The Yen Continues To Rally

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Includes: EWJ, FXY
by: Societe Financiers

Summary

The government does not take seriously the disadvantages of the negative interest rates policy.

The monetary actions aimed at stabilizing the JPY will not be effective.

The likeliest scenario is that JPY will continue to gain against the US dollar.

The Bank of Japan's authorities have continued to support the policy of negative interest rates. On January 29, 2016, the Bank of Japan announced the establishment of negative interest rates on excess reserves: namely, the new deposits that credit institutions would place in the Central Bank. The rate currently stands at 0.1%. This measure is designed to increase inflation, which, in turn, should stimulate growth in the Japanese economy.

In fact, the negative rates mean that central banks refuse to raise funds from commercial banks. Thus, the central authority is trying to encourage the banking sector by providing liquidity to commercial banks, while these banks' revenues will be shifting to riskier products (versus financing the government through treasury sales).

At the same time, the Japanese banks now impose costs on customers opening new deposits, forcing the Japanese people to keep their money under the mattress. The Central Bank hopes that people will start investing money in real assets instead of holding it in savings accounts.

Currently, the Japanese yen continues to strengthen against the US dollar: since February 2016, the JPY has strengthened by more than 12%.

Click to enlarge

(Source: Investing.com)

Inflation in Japan for the month of February totaled 0.3%, which is within the band instituted by the monetary authorities. The CBA plans to increase inflation up to 2% per annum - a level considered optimal for developed countries.

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(Source: tradingeconomics)

In March, the Japanese business activity index (i.e. PMI) declined to a level of 49.1 from 50.1 in February. This is the fastest monthly decline since February 2013:

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(Source: tradingeconomics)

On April 11, the Chief Secretary of the cabinet of ministers of Japan, Yoshihide Syugaev, announced that the government is always closely monitoring the currency market and added that the recent dynamics of the yen is one-sided and speculative.

In the short term, investors are betting that the Japanese officials will refrain from taking any action to stop yen's appreciation, at least until the G-20 meeting next week in Washington.

Conclusion

In the medium term, the most likely scenario for the yen will be the preservation of negative interest rates and its further strengthening to the parity with the UD dollar. A decrease in the PMI, the next release of which will be on April 22, 2016, will serve as another catalyst for the strengthening of the yen. A decline in production, mainly caused by the decrease in exports due to the strengthening yen, will be the cause of the expected decline in PMI. It is worth paying attention to the actions of the Bank of Japan's monetary authorities at the next meeting on April 27-28.

An alternative scenario may also take place if the Central Bank makes an intervention in the currency market in order to stabilize JPY. This will only have a short-term effect on the pair, while also greatly expanding the Central Bank`s balance sheet. This option is very unlikely and, as we see it, is only a lever that can be used by the Japanese authorities in order to uphold the PMI by increasing budget expenditures.

Societe Financiers is an investment research team focused on long-term, long- and short-only ideas. Our research objective is to cover equities in various regions, such as North America, EMEA, Asia, Australia, and Emerging Markets.
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