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Fundamental Forecast for Japanese Yen: Neutral
Japan’s economic policy mix looks to be locked in place for now. On the fiscal side of the equation, Prime Minister Shinzo Abe delivered a widely expected sales tax increase, pushing the rate from 5 to 8 percent as of next April. This was coupled with a ¥5 trillion stimulus plan – allegedly to be financed without new bond issuance – designed to offset the tax hike’s negative implications for overall economic growth.
A proposed cut of the corporate tax rate has been tabled for the time being. While Abe talked up the urgency of studying such a move as soon as possible, his very own Finance Minister Taro Aso hinted otherwise, stressing any reduction would be at best a medium- to long-term prospect. Details of the stimulus plan, due in December, amount to the next major inflection point.
On the monetary side, the Bank of Japan opted to maintain the existing policy once again last week. The central bank will continue to expand the monetary base at an annual pace of ¥60-70 trillion until price is growth is “stable” at the 2 percent target threshold. BOJ Governor Haruhiko Kuroda said the current easing effort is probably enough to reach the price growth target in spite of sales tax increase and praised the government’s stimulus plan as a major plus for the economy.
A meaningful change from this posture seems unlikely in the near term. Indeed, early signs the central bank’s efforts appear to be bearing fruit: the benchmark year-on-year CPI growth rate rose to a five-year high in August and inflation expectations priced into bond yields have notably increased since the beginning of the year to the BOJ will hit its target by late 2014.
A static domestic landscape puts the Japanese Yen at the mercy of risk sentiment trends. The correlation between an average of the currency’s value against its top counterparts and the benchmark Nikkei 225 stock index now stands at -0.61 (on 20-day percent-change studies). This speaks strongly of the unit’s safe-haven credentials, hinting a downward shock to Japanese equities is likely to send the Yen higher (and vice versa). With political instability in Italy now on the back-burner, the source of any such a dislocation is most likely to come from within Washington DC.
The shutdown of the US government continues for now but the growing proximity of the October 17 debt ceiling deadline is almost certainly fueling frantic deal-making behind closed doors. That elevates headline risk, with the sudden emergence of an accord that boosts risk appetite and sends the Yen lower an ever-present possibility. By the same token, news-flow decrying continued deadlock is likely to be supportive of the Japanese unit.
Meanwhile, the Federal Reserve will reveal minutes from September’s controversial FOMC policy meeting. Traders had widely expected the first move to “taper” QE asset purchases at that sit-down only to be disappointed, prompting sharp volatility across financial markets. While the government shutdown has potentially changed the calculus behind the FOMC’s decision-making process after September’s FOMC outing, the report may help illuminate some of the moving parts investors ought to watch to handicap the Fed’s trajectory.
A sense of immediacy in policymakers’ support for a reduction of QE is likely to help the US Dollar’s yield profile, sending USDJPY higher. Yen crosses may suffer however considering such an outcome is likely to spark risk aversion and encourage haven flows into the Japanese unit. Needless to say, a more cautious tone that speaks to a reluctance to tinker with asset purchases in the near term stands to produce the opposite effect.
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