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Japanese Yen Takes A Nosedive After BOJ Sets Negative Interest On Excess Reserves (IOER)

by Ed Wijananakula, NMS Investment Research

The USD/JPY exchange rate surged 1.9% to 121.08 yen per dollar at 10:35 P.M. EST on Thursday, before pulling back sharply after the Bank of Japan (BOJ) said after its two-day rate review that the bank will apply a negative 0.1% interest on excess reserves (IOER) of financial institutions placed at the bank, effective February 16. The BOJ also said it left the buying program of government bonds and exchange traded funds (ETFs) unchanged. After the FX market digested the headline news, the currency pair moved higher again to close at 121.05 yen per dollar on Friday, up 1.89% for the day.

The BOJ move should not have come as a surprise, as the turmoil in the global financial markets and declines in crude oil prices have triggered massive capital inflows into safe-haven currencies, such as the Japanese yen. As Japan is an export-oriented economy, an appreciating yen is a negative for Japanese trade and vice-versa.

Recent data shows that Japanese consumer spending is still weak, despite that the jobless rate in Japan stood only at 3.3% in January. Japanese household spending fell 4.4% year-on-year in December, missing economists' forecasts for a 2.4% decline, according to the Ministry of Internal Affairs & Communications of Japan on Friday. It was the fourth straight month of declines and the biggest drop since March 2015.

Earlier in the week on Wednesday, the Ministry of Economy, Trade and Industry of Japan said retail sales dropped 1.1% year-on-year in December, the second month in the row, as mild winter weather hurt sales of winter clothes, fuel and other seasonal products. A Bloomberg poll expected sales to increase by 1%.

According to the Japan Times in late December 2015, the Cabinet Office of Prime Minister Shinzo Abe said it expected the Japanese economy to grow about 1.7% in real terms in fiscal 2016, starting in April, led by recovering consumer spending and solid capital investment. The government said that around 0.3 percentage points of the overall growth will come from an increase in demand prior to the planned consumption tax rate hike in April 2017, up from 8% to 10%.

Japan's inflation was still near zero ahead of the BOJ's two-day rate review. Last Friday, BOJ Governor Haruhiko Kuroda said during an interview with Bloomberg in Davos that the BOJ was prepared to expand bond purchases if necessary to achieve its 2% inflation target. Kuroda's comment sent the USD/JPY exchange rate up 0.88% and the WTI crude oil price skyrocketing 8.04% that day on short-covering.

The U.S. economy doesn't fare much better, as the Commerce Department said on Friday that the advance estimate of gross domestic product for the fourth-quarter 2015 was 0.7%, missing economists' expectations of a 0.8% gain. For the full-year 2015, the economy grew 2.4%, unchanged from 2014. Separately, the Commerce Department said Thursday that durable goods orders tumbled 5.1% last month, after declining 0.5% in November. Economists polled by Reuters had forecast durable goods orders to fall just 0.6% in December.

As of January 26, there were 59,819 short positions of Japanese yen, traded on the Chicago Mercantile Exchange in units of 12,500,000 Japanese yen, by leveraged funds, a decrease of 1,947 contracts from the previous week, according to the Commitment of Traders data released by the Commodity Futures Trading Commission (CFTC). This is compared to about 77,549 long positions, an increase of 6,071 contracts during the same period. The hedge funds were piling onto the long positions as the net long positions increased by 8,018 contracts, worth about 100.23 billion yen.

USD/JPY Technical Chart

From our technical viewpoint, the USD/JPY has been trading in a symmetrical triangle chart pattern, a trading band between 116 yen per dollar and 125 yen per dollar. On August 11, traders became more bullish on the Japanese yen after the People's Bank of China (PBoC) allowed the yuan to depreciate nearly 2% against the U.S. dollar, triggering massive capital inflows into safe-haven currencies, such as the Japanese yen. Since then, the USD/JPY has been moving in a descending wedge chart pattern.

The BOJ's recent move has sent the USD/JPY upward to retest the upper trendline resistance of the descending wedge, and eventually towards the 124 yen per dollar level if the Federal Reserve decides to continue with their planned rate hikes this year.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.