Market Bias Towards BOJ Easing Weighs On JPY

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Includes: FXY
by: FX Analyst
Summary

Japan had better than expected Q12015 growth but further growth is not expected to be as strong as seen in surveys.

The market would presume that the BOJ is poised to ease monetary policy given its previous success.

FXY is likely to stay at the 78.5 to 79 if there is no other bad news.

The Japanese yen (JPY) was cheered on by the stronger than expected GDP growth in the first quarter of the year. However it swiftly came back to reality with the weak economic watcher sentiments and the weak consumer confidence. The unwillingness of consumers to spend had been the major source of headache for the Bank of Japan as it aims but fails consistently to reach the 2% inflation target.

The BOJ had seen the early fruits of its easy monetary condition which brought about strong economic growth together with partially implemented structural reforms. Hence it would not go soft on its monetary policy and we saw a 4% growth in M2 money supply over expectations of 3.6% for the month of May as the BOJ made its presence felt in the Japanese equity and sovereign bond markets.

Strong Q12015 Growth

This would continue to weigh on the JPY much more than the revised GDP reading for the first quarter. At best, the CurrencyShares Japanese Yen Trust (NYSEARCA:FXY) would stay at the 78.5-80 level. However Japan is particularly sensitive to bad news now and the JPY would weaken if there are further hints that Abenomics had not worked its magic on the economy.

Weak Economic Outlook in Survey

The Cabinet Office released the latest revision of the GDP numbers for the first quarter of 2015 and they look solid. The Q12015 GDP grew by 1.0% compared to previous estimate of 0.6% when compared to Q42014. For the annual comparison, Q12015 GDP grew by 3.9% from Q12014 instead of the 2.4% as previously estimated.

These GDP gains are driven by stronger capital expenditure, private consumption and residential investment. However the question remains if this growth would sustain into the future. If you were to take step back and look at Japan's GDP performance as seen in the chart below, you will notice that for the past 12 quarters, 6 quarters are contracting. This means that Japan is prone to recession and it had now managed 2 consecutive quarters of growth after extraordinary monetary easing measures by the BOJ.

The question as to whether it will be sustained can be seen in the economic sentiment and consumer sentiment surveys. For May, the economic sentiment was still above 50 and positive but it has slipped from 53.6 in April to 53.3 in May against expectations of 54.2.

This has bought concern over the sustainability of the recovery as the economic sentiment turned positive just 4 months back. This disappointment is being reflected in the consumer sentiment which came in at 41.4 in May over expectations of 41.9.

This decline is due to the perception of lower employment opportunities among consumers and this led to a subsequent unwillingness to spend. In addition, an increased number of Japanese consumers expect prices to stay the same. This represents a challenge to the BOJ 2% inflation target.

Conclusion

While the Japanese economy grew at a solid pace in the first quarter, the market is now focused on the upcoming quarters of growth. The FXY strengthened on the news but without positive further stimulus, it is unlikely to continue. Currently the market sentiment is slightly negative for the JPY as the market doesn't believe that Japan will do well in the second quarter. Hence my view is that unless proven otherwise, the FXY would stay at the 78.5 to 79 area provided that there is no impactful negative news. As of now, the market presumption is that the BOJ would be poised to initiate even more aggressive monetary policy should there be bad economic news in order to spur the Japanese economy and they will be bearish on the JPY.

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