Do not fight the Bank of Japan …especially not when it is at the forefront of the economic experiment known as Abenomics.
This is a lesson many currency traders have taken to heart since Shinzo Abe returned to power as Japan’s prime minister in December, and launched his war against deflation in order to shock the Japanese economy back to life.
Mr Abe’s battle plan has three parts: an aggressive monetary policy led by the BoJ, a flexible fiscal policy to increase demand, and an investment-inducing growth strategy for the private sector.
The yen has dropped 15 per cent against the dollar and 14 per cent against the euro since the start of the year as shorting the yen became the forex world’s favourite trade.
However, many of the moves were driven by speculation rather than reality, with hedge funds front running policies that had yet to be confirmed.
The market was preparing for disappointment in the lead-up to the Bank of Japan’s meeting in the first week of April, with traders arguing the BoJ would fail to surprise a market in which so much had been priced in.
They were, for the most part, wrong.
Haruhiko Kuroda, the Bank’s new governor, and his deputies acted with a scale and unanimity that shocked jaded markets and pushed the yen down near Y100 versus the dollar and Y130 versus the euro, levels not seen for three years or more.
They opened the floodgates by announcing the introduction of “quantitative and qualitative monetary easing”. This amounted to a “massive” doubling of the monetary base, and the average maturity of the Japanese government bonds purchased by the bank, as it sought to achieve its goal of 2 per cent inflation within two years.
The BoJ’s decision was almost unanimous, with only one board member voting against the commitment to keep easing.
The Bank also committed to keep easing until Japan’s 2 per cent inflation target has been steadily achieved, even if that promise has been tempered somewhat by Mr Kuroda saying this goal will be pursued “flexibly”, and that he would consider adjusting its aggressive easing policy if it led to unwanted side effects such as asset bubbles.
Many remain unconvinced by the longer-term efficacy of the moves, arguing that it is what happens with the money being created that counts. They add that there is no neat relationship between QE and the currency, and that previous bouts of QE did not have an overwhelming effect on the yen.
As outgoing Bank of England governor Mervyn King said regarding monetary policy: “It’s as if you’re running up an ever steeper hill.”
Geoffrey Kendrick, head of European foreign exchange strategy at Nomura, says he believes most of the BoJ’s plan was now reflected in its price against the dollar.
He expects the yen to hit Y100 against the dollar but to drift sideways afterwards, as the low yields on offer in the US send cash to riskier, more profitable locations.
Mr Kendrick also suggested high beta currencies, such as the Mexican peso, the Australian dollar, the South African rand and the Russian rouble, were most likely to benefit.
However, the sheer scale of the BoJ’s planned expansion has convinced others, with UBS’s economics team, for example, arguing the yen is “only about half way through its current declining trend”.
Unsurprisingly, Abenomics continues to divide.
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