USD/JPY: Same as before? - Rabobank

Jane Foley, Research Analyst at Rabobank, suggests that the BoJ have been up against a rock and a hard place this year as on one side has been the continued elusiveness of the 2% inflation target on the other has been growing scepticism about the side effects of extraordinary levels of fiscal stimulus.

Key Quotes

“In an attempt to reconcile these two forces the BoJ has opted to tweak the parameters of its existing policy. The BoJ has decided to exert more control over the yield curve, broaden the coverage of the ETF programme and has issued a commitment to overshoot the inflation target.

The commitment to overshoot the inflation target has a smoke and mirrors element. It could be argued that the BoJ are attempting to divert attention from the fact that it has given up attempting to achieve a price stability target of 2% at a specified date, which could be seen as a less accommodative step. Others may see today’s change as a pragmatic alternative to the continual pushing forward of its target. Generally it can be assumed that all major central banks would favour an overshoot in inflation since this suggests that when policy is eventually tightened the resultant sharper increase in interest rates will return to policy makers sufficient leeway to deal with the next economic downturn. This desire, however, doesn’t change the fact that most major central banks are failing to muster much inflation.

For Japanese banking stocks there has been clear relief that the BoJ has not taken further action to steepen the yield curve (though the door has been left open). The resultant better tone in the Nikkei 225 probably helps explain why USD/JPY was dragged higher as an initial market reaction. That said we maintain that it will be the Fed, via its impact on the US yield curve, which will retain greater control on the outlook for USD/JPY.

Despite the extraordinary amount of policy stimulus this year, the BoJ has not had much success in weakening the JPY vs the USD. Indeed, measured from the start of this year the yen is around 15% stronger vs the USD. Central banks such as the ECB, RBA and RBNZ are in a similar boat.

While the timing of the next Fed rate cut remains a primary market focus, as important are expectations regarding the trajectory of interest rate hikes into 2017 and beyond. It is our view that the Fed can hike once in December and once during 2017. However, currently it would appear that there are downside risks to this view and we wouldn’t rule out the possibility that the next rate move could be delayed until 2017 or even that the Fed is forced to formally pause it tightening programme. In the absence of a rise in US inflation expectations it is difficult to expect the USD to gain much upside traction. This is turn limits the downside for currencies such as the JPY and the EUR vs. the USD. We continue to view the 100 to 105 range as likely to contain USD/JPY in the months ahead. Given the risk of politically motivated safe haven demand the bottom end of this range is likely to be favoured.”