USD/JPY Monthly Fundamental Forecast – September 2016

The USD/JPY moved to the 103 range at the very end of the month but averaged just 100 for most of the month which has weighed heavily on the Japanese economy. The pair is up just 0.3% for the month but down 5% on a ytd basis. The currency pair remains a strong buy as the dollar gains or the Bank of Japan will be forced to add more stimulus lowering the value of the yen. The central bank announced a comprehensive review of its policy framework for its September meeting, suggesting the central bank’s willingness or ability to take further action is limited. With the risk of additional BoJ easing measures reduced and the Fed likely on hold this year, USDJPY should stabilize around current levels supported by recent electoral developments. New fiscal stimulus measures have also fallen short of market expectations, weighing on local stocks and boosting the JPY. The Japanese authorities will remain wary of speculative or market-driven bouts of JPY appreciation but we think the risk of intervention to curb JPY gains is limited at the moment.

The US Fed is warily heading towards its first interest rate rise since 2006, both the ECB and the Bank of Japan may soon expand their quantitative easing (QE) programs and China is expected to allow a big devaluation of its currency, see our Outlook on the financial markets. Given that the central banks are applying more of the same medication, we are expecting the outcome to be more of what we have already seen, which is weaker currencies (although this is obviously something that cannot be achieved collectively against each other’s currencies) and slightly higher inflation expectations. However, if the Eurozone leaders fail to support the ECB’s policy with solutions for structural economic problems, then the Eurozone runs the risk of falling into the Japanese trap in which increasing amounts of QE are required to prevent stagnation and deflation.

Shortly after his election at the end of 2012, the Japanese prime minister Abe launched ‘Abenomics’, a three-pronged economic program aimed at getting Japan back on a path of growth and inflation. In the first place there was a substantial fiscal stimulus to bolster domestic demand. Seeing gross national debt at about 250% of GDP –increasing to about 400% of GDP in 2050 in a no policy change scenario – this subsequently required fiscal consolidation.

Given that the economy is not yet sufficiently robust to absorb the fiscal consolidation through growth, the Japanese model rests primarily on a weak yen and additional monetary easing by the Japanese central bank where necessary.

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