USDJPY Up Ahead Of More Fed Tapering Clues, BOJ Talk

The latest economic figures from Japan are promising at most, but it is still too early to call Abenomics a success. Structural issues remain, and should keep the Bank of Japan on its Abenomics course. Furthermore, the yen could continue to depreciate as investors seek yield in the US.

So far, data from Japan looks good with the GDP growth rate picking up into positive territory during the first half of 2013. The Japanese manufacturing sector is showing some healthy signs too as the Tankan index rebounded in June, indicating positive business sentiment.

Weak structural trends in Japan remain
However, the May current account surplus missed expectations and narrowed to JPY 540.7 bn with exports up 9.1 percent year-on-year and imports up 0.6 percent in the same period. Export growth is strong thanks to the depreciating yen, but Japan's Prime Minister Shinzo Abe still has more arrows to shoot.

Structural trends in Japan are still weak; a shrinking workforce amid a population heavily skewed to the elderly is a deep concern that will require a more sustainable long-term policy agenda. Japan has a high corporate tax rate relative to other major countries, although Abe has a plan to ease that constraint to influence business growth. Co-operation on both the fiscal and monetary side is needed to pave a more sustainable growth path for Japan, and the markets are paying close attention.


Source: The Cabinet Office

Inflation target needs support of weaker yen
Abe’s two percent inflation target is bold, and I suspect that the BoJ realises that this will be a challenge, which is why it was so indecisive in accepting it, but ultimately felt under pressure to comply with the policy stance. Japan’s core inflation rate slipped further to -0.9 percent earlier this year, and is now back near -0.3 percent as the country continues its battle against deflation. The inflation target will need the support of a weaker yen, and the BoJ understands this well. Analysts are saying that USDJPY should stabilise near the 95-100 range in order to allow inflation to gradually pick up according to plan. Moves above 100 will be more than welcomed and with the current dynamics in the currency market we could possibly see that.

Japanese yields remain low, but have recently increased along with the US 10-year Treasury bond as Japanese investors took an exit route amid the bond sell-off after the US signaled its readiness to taper asset purchases (contingent upon data of course). A recent Wall Street Journal article states that this recent sell-off in Japanese and US bonds “overwhelmed any yield spread Japanese investors get from owning US bonds” – only slightly in the interim though. Keep in mind that with some uncertainty over Abenomics, especially so early in the process, much of the FX implications will come from the USD side.

Further USD support on FOMC minutes
USD could see further support after the Federal Open Market Committee June 18-19 meeting minutes are released on Wednesday and better economic data supports the rise in yields. The market is not taking the better headline prints from the US in totality for the yield quest, but what we see is that much of the worries about the Federal Reserve's tapering are being priced in. If we get a sense that the Fed's governing board was generally more approving of scaling down asset purchases by voicing concerns over balance sheet risks and keeping that possibility on the table if macro data forecasts are correct, then the USD will continue to be supported. With the BoJ monetary policy meeting on Thursday and its monthly economic review for July on Friday, expect Japan to defend the need for monetary stimulus but reiterate that it is still too early to act.