The Strength Of The Japanese Yen Could Doom Abenomics

The Japanese yen saw significant gains as traders continue to flock to safe havens. Against the US dollar the yen gained 63 points to trade at 112.22 and against the euro at 127.22 gaining 78 points. The strength of the yen is wreaking havoc on the Bank of Japan and Prime Minister Abe’s plans to keep the yen weak to help compete in global exports.  When Prime Minister Shinzo Abe launched his three-pronged program to revive Japan’s stagnant, deflationary economy three years ago, the stock market cheered every step along the way.

The “third arrow” of Abenomics — reforms to make the economy more productive — is barely a work in progress, but Abe got straight to work on the first two, fiscal expansion and monetary stimulus, with the enthusiastic support of a new governor at the Bank of Japan Haruhiko Kuroda. Despite the easing, the yen is near its strongest level in more than a year, dimming the prospects for exporters.

The headwinds, such as slowdown in China, weak external demand and the oil market rout, are mainly beyond the control of Abe and Kuroda. But that is why investors think Japanese policymakers are pushing against a piece of string, despite Kuroda’s defiant talk that there is no limit to monetary easing.

Unfortunately for Japan, Kuroda has very nearly reached the endgame. That is, the BoJ’s counter-cyclical capacity is exhausted. Expanding QE any further risks seriously impairing liquidity and market function and taking rates further into negative territory risks more cancelled JGB auctions which in turn inhibit QE. There’s simply nothing else the central bank can do.  With Abenomics having thus failed miserably, traders are sitting back and waiting for the day when Abe and Kuroda finally fall on their swords.

With the economy stumbling, Tokyo shares fell 2.3% Wednesday, erasing nearly all the gains since the Bank of Japan ratcheted up its easing program in October 2014. And the yen was trading near its highest level in more than a year—highlighting a flight to safety that was exactly the opposite of what the central bank intended.

The US dollar index a gauge of the dollar versus 10 major peers was near its lowest level since November after Ms Yellen’s comments initially buoyed American stocks, before they retreated into the close. While Australia’s benchmark snapped a four-day drop, futures on US indexes declined, with markets in Tokyo, Shanghai, Taiwan and Vietnam shut Thursday, as those in Hong Kong and South Korea return. Australian 10-year bonds advanced for a third session following an advance in Treasuries. US crude traded below US$28 a barrel.

The greenback remains weak in the Asian session at 95.81. The Aussie and kiwi which initially gained against the weak dollar reversed course and are trading in the red as traders continue to run from commodities and commodity linked currencies. The Aussie is trading at 0.7091 and the kiwi at 0.6668. The greenback The dollar held losses, trading near its weakest level since 2014 against the yen, after Janet Yellen signaled the Federal Reserve may put off further interest-rate increases should the turmoil in global markets continue.

Markets in mainland China and Taiwan remain closed for the rest of the week for the Lunar New Year holidays, while Japan resumes Friday.