BoJ policy uncertainty could lift yen volatility in 2017 - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the yen has strengthened during the Asian trading session extending its gains after USD/JPY broke below technical support at around the 117.00-level which had provided a temporary floor over the holiday period.

Key Quotes

“The next key support level comes in at just above 115.00 where the pair was trading prior to the more hawkish than expected FOMC meeting on the 14th December. The sell-off in the US bond market has lost some momentum in the near-term allowing the yen to trade on a firmer footing. The yield on the 10-year US Treasury bond has dipped back below 2.50% moving further below the recent peak at 2.64% from the 15th December which also coincided with USD/JPY’s recent peak at 118.66.”

“The latest IMM report revealed that speculators have sharply increased short yen positioning over the last month reaching its highest level since the same period of last year. The more stretched short yen positioning creates some scope for the yen rebound to extend further into early next year if the sell-off in the US bond market has already reached a crescendo in the near-term.”

“The renewed weakness of the yen is contributing to a more upbeat outlook for Japan’s economy in the year ahead which is expected to record both faster growth and inflation. In a rare exclusive interview with the Nikkei overnight, BoJ Governor Kuroda continued to strike a more optimistic tone stating that “looking ahead to next year…I think the global economy is clearly headed toward a good direction”. “Japan’s exports and production are picking up, and private consumption is showing signs of strengthening, Japanese stock prices are on the rise, and the excessive strength of the yen is being corrected…I think this means that the obvious recovery in the global economy, as well as less “risk off” market, will greatly benefit the Japanese economy next year”.”

“However, he did still caution that the “new phase” for the global economy does come with some risks including the potential for a further rise in isolationist and protectionist sentiment and resulting policies. Governor Kuroda remains more cautious over the outlook for inflation as well stating that “I think we are still not in condition where we can say we have escaped deflation, or that we can achieve the 2% price stability target”. He also called on the government to do more structural reforms. His comments suggest that the BoJ remains committed to maintain current loose monetary settings in the near-term which remains a heavy weight on the yen.”

“Nonetheless there are still doubts over how long current loose monetary policy settings can be sustained. In an interview with the WSJ former BoJ Deputy Governor Kazumasa Iwata expressed doubt over whether the BoJ will be able to maintain their yield target for the10-year JGB at around 0%. He sees three problems facing the BoJ if they attempt to hold down JGB yields. Firstly, he believes it would require the BoJ to even more buy bonds which could push its purchase program closer to its limits. Secondly, he believes that the current target for the 10-year JGB yield at around 0% is “inconsistently low” compared to the negative -0.1% short-term rate target. Thirdly, he believes that the shape of the yield curve being sought by the BoJ is “unnatural” in the eyes of market participants.”

“He has suggested that the BoJ could allow the 10-year JGB yield to rise gradually in a similar style known in the FX market as crawling peg; or another option would be for the BoJ to set the ceiling at 0.2% and the floor at -0.2% while letting the yield move within the range. However, he warned that controlling long-term interest rates could prove to be as difficult as controlling foreign exchange rates. The ongoing uncertainty over the sustainability of the BoJ’s current loose monetary policy settings remains a factor which could result in higher yen volatility in the year ahead.”