FX Watch
Group Economics Macro & Financial Markets Research
14 April 2016
What is driving the JPY? Roy Teo Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com
Declining real interest rate spreads have supported the JPY
Inflation expectations a more crucial driver
Global growth concerns and rising Chinese yuan volatility
Hurdle rate for currency intervention is high after the G20 meeting
Enhancements to QQE program and Loans support program this month
USD/JPY to rise to 115 by the end of 2016
Declining real interest rate spreads have supported JPY strength Since the beginning of this year, market concerns of a slower US economy have weighed on both short and long term yields in the US. At the same time, the Fed’s preferred measure of inflation have continued to edge higher. As a result real yields in the US have declined. In Japan, though nominal yields have also moved lower since the Bank of Japan introduced negative interest rates in January, inflation ex food, energy and effects of sales tax has declined by a similar magnitude. In short since the start of this year, real interest rate spreads between the US and Japan have plunged and this has supported a stronger Japanese yen (JPY) versus the US dollar.
USD/JPY; Real 2y US-JP yield spread
USD/JPY; Real 10y US-JP yield spread
Level
%
130
1
120
Level
%
130
2
120 0
110
1 110
100
-1
90
100
0
90 -2
80
-1 80
70 Jan-11
-3 Jul-12
USD/JPY (lhs)
Jan-14
Jul-15
Real 2y US-JP yield spread % (rhs)
Source: Bloomberg, Ministry of Internal Affairs Japan, US Bureau of Economic Analysis, ABN AMRO
70 Jan-11
-2 Jul-12
USD/JPY (lhs)
Jan-14
Jul-15
Real 10y US-JP yield spread % (rhs)
Source: Bloomberg, Ministry of Internal Affairs Japan, US Bureau of Economic Analysis, ABN AMRO
Insights.abnamro.nl/en
2
FX Watch – What is driving the JPY? 14 April 2016
Inflation expectations a more crucial driver However the yen weakness bottomed against the US dollar in the middle of 2015, about six months before real interest rates spreads between the US and Japan declined. So what was the catalyst? Our analysis show that nominal interest rate differentials adjusted for inflation expectations between the US and Japan peaked about the same time as USD/JPY in the middle of last year. Hence this is likely to be a better indicator and explanation of movements in USD/JPY. Indeed, the correlation between USD/JPY and nominal interest rate differentials adjusted for inflation expectations is slightly stronger than real interest rate differentials (nominal interest rates adjusted for inflation).
USD/JPY; 10y US-JP yield inflation expectations adjusted Level
%
130
1
120
0
110
100
-1
90
-2
80
70 Jan-11
-3 Apr-12
Jul-13
Oct-14
Jan-16
USD/JPY (lhs) 10y US-JP inflation expectations adjusted yield spread % (rhs) Source: Bloomberg, ABN AMRO
Global growth concerns and Chinese yuan volatility have supported the yen Worries about slower global growth, uncertainty surrounding the Brexit and rising volatility in the Chinese yuan have also supported the yen. As the strength in the yen has persisted over recent months, investors have started to speculate and hedge open positions in the currency options and swap market. This further supported the yen. Yen carry trades have been unwound and speculative futures positions have also turned from net short to net long as the downtrend in USD/JPY has persisted.
JPY NEER; 1mth USD/CNY volatility
Speculative futures positions turn positive in 2016
Level
Level
Level
Reverse scale Number of contracts
115
10
125
-150000
110
8
115
-100000
6
105
-50000
4
95
0
2
85
50000
0
75 Jan-11
105 100 95 90 85 Jan-13
Jan-14 JPY NEER (lhs)
Source: BoJ, Bloomberg
Jan-15
Jan-16
1mth USD/CNY volatility (rhs)
100000
Jan-12 USD/JPY (lhs)
Source: Bloomberg
Jan-13
Jan-14
Jan-15
Jan-16
Speculative futures positions (rhs)
3
FX Watch – What is driving the JPY? 14 April 2016
Hurdle rate for currency intervention is high after G20 meeting Recently, Prime Minister Abe echoed the G20 meeting stance that countries should avoid competitive devaluation and refrain from arbitrary intervention in the currency markets. As a result the downward momentum in USD/JPY accelerated in early April with prices breaking below 108. In addition, the JPY nominal effective exchange rate (NEER) and realized volatility are not at extreme levels and hence it will be difficult for Japan to justify a currency intervention given the current scrutiny from other G20 economies. In addition, according to purchasing power parity, the yen is still undervalued. Recently the IMF has stated that the recent yen strength has not altered their view that the yen moves are broadly in line with fundamentals. According to Japan’s Cabinet Office, the breakeven USD/JPY rate for exporters is around 100. In our view, currency intervention closer to this level will be more justifiable to the international community even if the JPY NEER and volatility does not rise to levels when the MoF last intervened in 2011.
Bullish bearish sentiment indicator in USD/JPY
JPY NEER and 1wk USD/JPY volatility
Sentiment indicator
Level
8 5 2
Volatility
135
25
125
20
115
15
105
10
95
5
-1 -4 -7 -10 Jan-11
Jan-12 Jan-13 Jan-14 Jan-15 Bullish bearish sentiment indicator
85 Jan-11
Jan-16
0
Apr-12 JPY NEER (lhs)
Source: Bloomberg
Jul-13
Oct-14
Jan-16
1wk USD/JPY volatility (rhs)
Source: BoJ, Bloomberg
Enhancements to QQE and Loans support program on 28 April likely In the next monetary policy meeting on 28 April, the BoJ is likely to increase the annual pace of asset purchases from about JPY 80 trln to over JPY 100 trln. As government bonds with tenors of 15 years and above still offer positive yield, there are less willing sellers for longer dated bonds.
10y JGB yield and auction bid to cover ratio Ratio
20y JGB yield and auction bid to cover ratio %
5
1.0
Ratio
%
5.5
2.0
0.8 4
0.6
1.5
4.5
0.4 3
0.2
1.0 3.5
0.5
0.0 2 Jan-13
-0.2 Jan-14
Jan-15
Jan-16
2.5 Jan-13
0.0 Jan-14
Jan-15
10y bond auction bid cover ratio (lhs)
20y bond auction bid cover ratio (lhs)
10y JGB yield % (rhs)
20y JGB yield % (rhs)
Source: MoF Japan, Bloomberg
Source: MoF Japan, Bloomberg
Jan-16
4
FX Watch – What is driving the JPY? 14 April 2016
The graphs above show that the bid-cover ratio for BoJ’s 10 year bond auctions remains strong (more willing sellers to the BoJ) compared to the 20 year auction. Hence the average maturity of JGB purchases will likely be extended slightly from the current 7-12 years to below 15 years. This will likely be combined with the expansion of ETFs and JReits purchases to 5 trln yen and 200bn yen per annum. In addition, the interest rate for the Fund-Provisioning Measure to stimulate Bank Lending conducted through the Loan Support Program could also be lowered from 0% to -0.1%. Interest rate cuts into further negative territory is only likely later this year in July as the BoJ has indicated that they would like to monitor the effects of January’s decision for some time. USD/JPY to rise to 115 by the end of 2016 In the past week, there has been some encouraging signs that the downtrend in USD/JPY is changing. For more details, please refer to FX Weekly – Commodity currencies rally published on 14 April 2016. Looking further ahead, we expect the yen to weaken towards 115 against the USD over the course of this year for several reasons. First, we expect inflation expectations in Japan to rise, supported by both fiscal and monetary stimulus in the coming months. More monetary stimulus would push down real interest rates in Japan by reducing nominal rates and increasing inflation expectations. This is likely to support USD/JPY. Second, higher oil prices is expected to reduce Japan’s current account surplus given that oil accounts for more than 20% of Japan’s imports. Third, volatility in the Chinese yuan is likely to ease lower as capital outflows concerns fade. Our regression analysis shows that there is strong relationship between the 1 year yuan implied volatility (which is trending lower) and realized 1 month volatility. Hence safe haven flows into the yen is likely to decline. Last but not least, it is evident that lower domestic yields (due to BoJ’s decision to cut interest rates into negative territory on 29 January) have resulted in domestic investors increasing their purchases of foreign bonds. As investors become more convinced that the yen strength trend has reversed, hedging and speculative activities currently in favour of yen will reverse.
USD/JPY; 5y5y Japan inflation swap rate Level
%
125
1.5
115
1.0
105 0.5
95 0.0
85 75 Jan-11
-0.5
Apr-12 USD/JPY (lhs)
Source: Bloomberg, ABN AMRO
Jul-13
Oct-14
Jan-16
5y5y JP inflation swap (rhs)
5
FX Watch – What is driving the JPY? 14 April 2016
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