Why have Japanese policy-makers been so successful in weakening the JPY? Ultimately, the impact of Quantitative Easing (QE) on a currency is dependent on whether the policy is successful in changing inflation expectations or whether the policy itself is directed at weakening the currency. An extreme example of this was the Swiss National Bank’s (SNB) decision to reverse at least a proportion of the Swiss francs’ massive overshoot through “unlimited” currency market intervention. In contrast, Federal Reserve and Bank of England QE programs were never directly focused on the international value of the US dollar (USD) or sterling (GBP), or even the raising of domestic inflation expectations. The impact of these special policies on the USD or GBP has been hard to isolate.
The Bank of Japan (BOJ) could not go as far as the SNB. Japan is simply too big a global player for others to countenance a similar scale of overt currency market intervention. However, its actions have gone a lot further than the other G4 central banks. In the build-up to and aftermath of Prime Minister Shinzo Abe’s election victory it had become clear that the central bank’s inflation target would be raised and that in order to reach the new goal, policy would be conducted in a more aggressive manner. It was also made clear that a depreciation of the currency was a vital transmission mechanism for raising inflation expectations. Crucially, this had credibility among investors because there was widespread acceptance that the JPY had become significantly overvalued.
Real Value of EURJPY
Using relative producer prices, working backwards from current spot
The scale of JPY adjustment has been a shock and its 13-week rate of decline is already the second most aggressive in over 20 years(1). With the recovery in the EUR also a feature in recent weeks, the move in EURJPY has been particularly aggressive. On our calculations, the real value of the JPY has now moved from being clearly overvalued against the EUR to being arguably significantly undervalued in just half a year. This is an important development as it is now very difficult to sustain an argument that the current levels of the JPY are a suppressant on Japanese growth relative to other G10 economies. Although last week’s G7 and G20 statements were not as “punchy” as some had feared, it is clear that further moves in the JPY that take it further into undervalued territory will not be welcomed.
Meanwhile, some of our macro indicators are no longer as negative on Japan as they were in the second half of last year. Remarkably, our proprietary leading economic indicator is now signalling above trend growth for Japan, and our BOJ Policy Indicator has moved aggressively in to less accommodative territory. Japanese domestic investors are a big player in the JPYs fortunes, and another large move lower in the currency will likely require more selling from them in coming weeks. This is far from guaranteed. Yields available outside of Japan have continued to fall on a relative basis, and JPY volatility has risen sharply from last year’s very low levels. And, of course, it could be argued that the main beneficiaries of a more pro-growth and inflation policy will be domestic Japanese equities and property. From current levels of valuation, how big is the incentive for Japanese investors to put more money overseas?
We still believe that more aggressive BOJ action to create inflation and reduced structural support from current account surpluses will undermine the JPY. However, the scale of the first phase of this adjustment has been dramatic and there are signs that further weakness from current levels will be harder fought and more erratic. The easy part of the “sell-JPY” trade may already be over. We have therefore reduced the size of our strategic short exposure.
(1) Calculated using the Bank of England nominal Trade-Weighted Index for the JPY