Well didn't the Bank of Japan surprise the markets today when it lowered interest rates into negative territory. This comes at a time of disappointing data releases where Household Spending, Industrial Production, Housing Starts, and the Tokyo CPI missed their respective estimates.
Sourced from Trading Economics
The effects of the cut were mixed depending on your view.
Unlike the Nikkei 225 (OTC:NTKIF) which bounced and closed 3% up on the news, unsurprisingly, the Japanese yen (NYSEARCA:FXY) has not reacted well to it by any stretch of the imagination. Sentiment was already bearish but this has taken things to another level.
Sourced from the CMC Markets platform
The immediate aftermath of the decision saw the USD/JPY pair spike up to levels not yet seen in 2016. As we write this, the USD is trading at 121.093 Japanese yen.
The move by the Bank of Japan was very surprising.
Haruhiko Kuroda and The Bank of Japan are not at all known for dramatic moves such as these, and the adoption of negative rates is going to be hard for the market to swallow. We expect further weakening of the yen to happen within a few months. Governor Kuroda had warned previously that he and the Bank of Japan would step forward with further easing if it became necessary. But we don't believe many market watchers ever expected this to happen, instead another round of its major asset-buying program was expected.
Inflation levels needed to improve.
It is not a secret that Japan has struggled with its inflation levels. The Bank of Japan has said in the past that if it doesn't act, it could find itself heading back to the same deflationary mindset that has hindered the third-largest economy in the world for a large part of the last twenty years.
Low inflation levels are bad for a number of reasons but for the Bank of Japan, we see the main one is the fact that inflation lessens the burden of debt making repayments much easier. As Japan has a tremendously high level of government debt to support its aging population, it needs a healthy inflation level to assist it managing its debt.
The Bank of Japan sees 2% as a healthy long-term target for inflation and as December's figures came in some distance from the desired target, Governor Kuroda has stayed true to his word and acted.
But will it be enough?
Kuroda has said that Japan has been recovering moderately and that the underlying price trend was rising steadily. He highlighted the risks posed by further falls in the oil price, uncertainty in China, and global market volatility hurting business and consumer confidence as major concerns. The negative interest rates have been adopted to prevent these risks from materializing.
In 2014, the European Central Bank was the first central bank to delve into negative interest rates. Things have picked up in the Eurozone recently, but it is hard to say whether that is down to the interest rates or other underlying factors.
What can be done now?
There are a couple of options for investors and traders to look at now. We see the Nikkei 225 index as an appealing long investment now. The Nikkei 225 has shed around 15% of its value in the previous six months and we now expect it to reverse these losses and climb back up to beyond the 20,000 level by the year's end.
On the short side, we see weakness forming in the Japanese yen against the GBP and the USD. We have a preference for the USD/JPY pair and think it will move up to 126 later this year from the current level of 121.093.
The preference stems from the high probability of two interest rate rises in the United States in 2016. When Janet Yellen and the Federal Reserve do increase rates again this year, we are confident in our prediction that the USD will strengthen to the point it overcomes any resistance that forms in the JPY, carrying it above 126.
The Bank of Japan's move today has given investors and traders a few options to consider. If they play out as we expect them to do, they will provide handsome returns.
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