USDJPY: Scope for Japanese politics to get some traction in the currency markets - HSBC

In view of Daragh Maher, FX Strategist at HSBC, the key driver of USD-JPY over the last year has been cyclical rather than political, although the exchange rate has been more attuned to the US economic cycle than Japan’s with the USD-JPY highly correlated to US Treasury yields.

Key Quotes

“Still, there is scope for Japanese politics to get some traction in the currency markets if the polls affect the probability the markets attach to the continuation of the BoJ’s ultra-accommodative monetary policy under Abenomics. Anything that suggests the policy might come to a premature end would likely see USD-JPY drop. For now, however, the opinion polls suggests little threat to the policy status quo. Yet even if this snap election does not rattle the currency market, it serves as a reminder that politics cannot be ignored and we continue to believe the failure of Abenomics to generate lasting inflation creates a gravitational pull for USD-JPY to fall back towards 100.”

“For a brief period, PM Abe’s decision to call a snap general election looked like it could echo the struggles experienced by the UK’s Prime Minister Theresa May with the result of the snap election there, earlier in the year. The sudden possibility that the Party of Hope could effectively utilise the Democratic Party’s political infrastructure to mount a potent challenge to Abe’s LDP saw USD-JPY weaken. The simple logic is that any challenge to Abe is a challenge to the mandate for Abenomics and, by extension, to the BoJ’s monetary stance. This FX market reflex is likely to remain in play throughout the election campaign and should also dictate the reaction to the actual result.”

“Opinion polls however suggest the challenge to Abe from the new make-up of the opposition is not likely to be strong. Perhaps the opinion polls will be proven wrong, in which case the surprise nature of an Abe defeat would see USD-JPY materially lower. If the picture painted by the opinion polls is borne out by the election results then the currency market will look for continuity in BoJ policy over the next couple of years (whoever is at the helm) and will not need to re-price the JPY. It is possible that the margin of any Abe victory could have some bearing on the currency. The narrower an Abe victory, perhaps the greater the question over the public’s support for Abenomics. Alternatively, retention of a super-majority for another parliamentary term might embolden JPY bears.”

“Yet beyond the knee-jerk JPY takeaway from the election result and what it signals in terms of support for Abenomics and continuity in BoJ policy, the greater issue for the currency is that Abenomics is simply not working. The timing of when the 2% inflation target will be hit has been snow-ploughed ever further into the future. The promises made back in 2012 of sustained inflation have not been met and the depreciation that the JPY underwent in anticipation of higher inflation looks excessive.”

“The BoJ has successfully massaged the 10Y JGB yield to zero, but this is not the target of policy, it is only the tool of policy to achieve the target of 2% inflation. There are no signs that focussing on the price of bonds rather than the quantity of bond bought is proving any more effective for the BoJ, and it also means that tapering is already underway in Japan. The policy failure and ongoing tapering creates a gravitational pull lower for USD-JPY, perhaps not all the way back to the starting point of 80 when those promises were first made. But a move back to 100 looks plausible and the snap election may merely determine how long it takes us to get there.”