USD/JPY: Good news and bad news - Rabobank

Jane Foley, Research Analyst at Rabobank, explains that the reflationary spirit that has taken hold of the US bond markets has injected a large amount of potency back into the BoJ’s monetary policy settings. 

Key Quotes

“The recovery in US yields started in October and the recent surge in their values and the USD can be associated with a significant loosening of the monetary conditions in several other economies due to exchange rate movements.” 

“The loosening in monetary conditions implied by the exchange rate will be a welcome relief to the BoJ.  Following a rise in concern about the side-effects of policies such as negative interest rates and QE, the BoJ in September announced a different tact.  The BoJ currently aims to keep the 10 year JGB yield at 0%.  Domestic bank shares rallied on the announcement on the expectations that a steeper yield curve would offer their business models relief.  However, this policy is unprecedented and there has been some concern as to how the BoJ would react to the upward drag on international bond yields caused by the movement in US treasuries.”

“On November 17 the BoJ concluded a special fixed rate bond buying operation for the first time to reassert its commitment to it QE programme and fire a warning short against expectations of excessive moves in JGB yields.   This commitment suggests that as long as the market believes in the reflationary power of the President-elect that the spread between US and JGB yields will widen and USD/JPY can fly higher.  In our view, however, the market may be over-anticipating the reflationary prospects of the USD and both treasury yields and the USD could correct lower medium-term.  While we have recently moved up our forecasts for USD/JPY, our expectation for a correction lower in US treasuries leads us to the conclusion that USD/JPY will also correct lower in the medium-term.  Consequently we are forecasting a move back to 110.00 on a 3 mth view.”  

“While the Japanese authorities will be grateful for the current strength of the USD, the Abe government is likely to be deeply concerned about the protectionist threats of the President-elect.  If Trump follows through on his threats, this has the potential to have severe consequences for Japan’s export outlook both directly and through its trade with China.  Yesterday Japan’s ambassador to China was reported as saying that the TTP was not completely dead. While it will be tough to resurrect the pact without the US, Japan is expected to play a leading role in the fight against isolationist policies in the coming years.”