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JPY: How long can weakness be sustained? - MUFG

The yen has recently strengthened resulting in USD/JPY falling closer towards the bottom of this year’s rough trading range between the 110.00 and 115.00 levels and has been one of the best performing G10 currencies this month which in part reflects more caution over the pace of further tightening from overseas central banks including the Fed and BoE, explains Lee Hardman, Currency Analyst at MUFG.

Key Quotes

“In particular the Fed has signalled more concern over persistently low inflation over the last week or so. It is likely encouraging a lightening of short yen speculative positions which earlier this month had reached their highest level since USD/JPY peaked at just over the 125.00-level back in the middle of 2015.”

“The yen is also benefitting from tentative signals that the BoJ could tighten monetary policy further in 2018. The BoJ has already started to slow the pace of JGB purchases as it has shifted its policy focus on to yield curve control. Recent comments from BoJ officials have signalled that they are beginning to consider tweaking yield curve control. BoJ Board member Hitoshi Suzuki stated overnight in an interview with the Mainichi newspaper that it’s possible to make slight changes to its yield curve control program when price growth approaches the 2% inflation target. He stated that it wouldn’t be strange if the BoJ conducted fine-tuning so market participants can familiarize themselves with a gradual process as inflation approaches 2.0% and there should be a discussion on it. He prefers a gradual tightening in advance of meeting the inflation target rather than a sudden rise in yields when the inflation target is achieved.”

“The comments follow on from a speech last month from Deputy Governor Hiroshi Nakaso in which he stated that they would make adjustments to the shape of the yield curve as necessary, taking into account the developments in the economy, prices and financial conditions. He noted that the “BoJ needs to establish a new benchmark that can be applied to the entire yield curve, and as part of devising such benchmarks, it has been proceeding with theoretical and empirical analysis from many aspects. These efforts include measuring the natural yield curve, which can be obtained from expanding the concept of natural rate of interest and comparing it with that during the past easing phase”. However, he did not elaborate on how and when the BoJ might adjust the shape of the yield curve.”

“BoJ Governor Haruhiko Kuroda commented on the concept of and measuring the “natural yield curve” in speech earlier this month in Switzerland. In the speech he commented on some of negative effects of low rates including the “reversal rate” which refers to the “possibility that if the central bank lowers interest rates too far, the banking sector’s capital constraint tightens through the decline in net interest margins thereby impairing financial institutions intermediation function so that the effects of monetary easing on the economy reverses and contractionary”. However, he did emphasize that “in Japan’s case, financial institutions have a solid capital base and credit costs have fallen sharply, so that at present their financial intermediation function is not impaired”,  although as “the impact of low rates on financial institutions’ soundness is cumulative, they will continue to pay attention to  this risk as well”.”   

“Overall, there is no clear indication yet that from the BoJ that it is on the verge of an imminent tightening of policy through yield curve control with inflation still well below target. However if tentative discussions over tweaking yield curve control continue to intensify going forward alongside a pick-up inflation, it could pose upside risks for the yen in 2018. The sharp strengthening of the euro so far this year highlights how building expectations over tighter monetary policy can quickly help to reverse domestic currency weakness especially when it is significantly undervalued. The yen is currently one the most undervalued G10 currencies leaving plenty of scope for upside.”

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