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01 29 2016 | by Victor Xing | Central Banks

Will the Japanese yen see further depreciation?

QQE with a Negative Interest Rate

There are several considerations following the surprise BOJ policy announcement on its new Quantitative and Qualitative Monetary Easing with a Negative Interest Rate (QQE with NIR – official release):

JPY’s depreciation vs. the dollar from mid 118 to low 121 – the 300 pips move is seen as modest compared to prior market reactions, such as following Governor Kuroda’s October 2014 effort to expand the central bank’s annual QE purchase target to 80 trillion yen ($724 billion) from 60-70 trillion.  Similar to October 2014, the latest BOJ policy decision also came with a narrow margin of 5-4 majority vote.

Japanese yen since 2014
USDJPY since 2014

Details on the negative interest rate (on one of the three tiers of bank reserves outlined by the BOJ, source: Bloomberg):

The negative rate will be imposed on reserves worth about 10 trillion to 30 trillion yen initially and will apply only to new reserves that financial institutions deposit at the central bank, according to people familiar with knowledge of the matter. The change will take effect on Feb. 16 and is similar to programs at some central banks in Europe, the BOJ said.

With the bulk of banks’ reserves continuing with a positive 0.1 percent rate, this could help to contain any negative spillover effects such as damage to their earnings that would undermine lending and growth.

Despite the more nuanced three-tier system in regards to financial institution’s current account at the BOJ (positive rate, zero rate, and negative rate), the inclusion of negative interest rate as part of monetary policy alone was to send a strong signal to the market place.  Nevertheless, a number of investors did begin to question whether the BOJ is “out of ammunition” in its fight against disinflation, especially one fueled by the forces of low commodity prices.

Additionally, the Japanese yen as a safe haven asset would appreciate amid global risk-off events, such as the oil rout and its collateral damage to the global energy complex, which raised fears that risk contagion would turn energy sector weakness into a large scale sell-off in broader risk asset markets (a view which I do not subscribe).  This illustrates the perspective that taking a view on USDJPY requires the following:

  • View on Federal Reserve policy path (yen would appreciate vs. the dollar on dovish FED policy path, or depreciate further if hawkish FED policy fuel another dollar rally)
  • View on Bank of Japan policy path (is Governor Kuroda prepared to triple-down on stimulus if the gap between realized inflation and policy objective continue to narrow at a disappointing rate?)
  • View on global risk sentiment – will stock markets face further turbulence and give fuel to a rebound in yen valuation?
Japanese yen vs. risk assets
USDJPY vs. SPX – safe haven asset vs. risk sentiment

Japanese yen valuation based on investment thesis

If an investor takes a 6 month view that the Federal Reserve will be more dovish than expected (note: expectation is key – financial markets are pricing in less than one hike in the entire year of 2016, therefore more dovish than expected will have to be no hike at all or a rate cut), risk sentiment will regain its footing (i.e. equities to recover further and oil price to stabilize), and the BOJ will ease more in the days ahead, then yes, the yen will depreciate further.

However, these are some tough macro calls.  Potential investors should exercise caution when others call for USDJPY at level Y at time X without providing specific views on these (or more) macro drivers

Personally I expect the following:

  • Oil to stabilize and U.S. equity market to recover
    • Weakness in the oil market is largely priced in (extremely bearish views are now calling for sub-$10 oil)
    • Further declines in oil prices will give strong economic incentives to shift more sources to oil and oil products, thus acting as an automatic stabilizer
    • The current “disinflationary status quo” of asset price & services inflation vs. goods disinflation to shift toward higher headline inflation
    • FED to pivot toward a more hawkish stance
  • The BOJ to keep policy on-hold for the next 6 months

Under this view, the Japanese yen would see further weakness vs. current levels (at 121.161) over the next 6 months.

Addendum 1: BOJ’s 5-4 majority vote on negative interest rate (source: BOJ)

Voting for the action: Mr. H. Kuroda, Mr. K. Iwata, Mr. H. Nakaso, Mr. Y. Harada, and Mr. Y. Funo. Voting against the action: Ms. S. Shirai, Mr. K. Ishida, Mr. T. Sato, and Mr. T. Kiuchi. The members voting against the action gave the following reasons: Ms. S. Shirai expressed concerns that introducing a negative interest rate immediately after the introduction of supplementary measures for QQE might be misunderstood as reaching a limit to the Bank’s asset purchases and that such a complex policy framework could cause confusion; Mr. K. Ishida considered that a further decline in JGB yields would not have significantly positive effects on economic activity; Mr. T. Sato considered that a negative interest rate should be introduced when the Bank slows down the pace of increase in the monetary base; and Mr. T. Kiuchi considered that introduction of a negative interest rate, which would adversely affect smooth conduct of the Bank’s JGB purchases, would only be an appropriate policy measure in a crisis situation.

Japanese yen and the policy divergence within BOJ

Policy divergence within BOJ MPB

Addendum 2: negative interest rate and BOJ’s three-tier system

Interest-Rate Dimension: The introduction of a negative interest rate by a 5-4 majority vote[Note 1]

The Bank will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank.1 It will cut the interest rate further into negative territory if judged as necessary.

Specifically, the Bank will adopt a three-tier system in which the outstanding balance of each financial institution’s current account at the Bank will be divided into three tiers, to each of which a positive interest rate, a zero interest rate, or a negative interest rate will be applied, respectively (see Attachment for details).2

The Bank will carry out the Loan Support Program, the Funds-Supplying Operation to Support Financial Institutions in Disaster Areas affected by the Great East Japan Earthquake, and the Funds-Supplying Operations against Pooled Collateral at zero interest rates.

Next article01 27 2016 | by Victor Xing | Central Banks

FOMC recap: dovish statement and “symmetric” objective