Bank of Japan risks triggering domino effect across forex markets
On January 23, Bank of Japan governor Haruhiko Kuroda advised China to impose capital controls to defend CNY – about a week a later he made China’s job a lot harder by setting Japan’s interest rates in negative territory for the first time ever.
The BoJ’s shock move has accentuated a number of dynamics in the forex markets, some of which could have unintended consequences.
The BoJ, is to cut rates from 0.1 to -0.1 on commercial bank balances at the central bank above certain minimum thresholds, which apes policies in Denmark, Sweden, Switzerland and the Eurozone. It’s supposed to make holding cash less attractive and to spur more lending and to speed the rate at which money circulates in the economy stoking some inflation and GDP growth.
Though negative interest rates are still fairly new, the results they’ve produced so far are mixed. They do bring a quick currency depreciation, but so far don’t seem to have stimulated much new borrowing or inflation or speeded up the velocity of circulation of money. Japan with its chronic demographics and high government debt is unlikely to do much better.
But it will make JPY, a forex major, more attractive as a funding currency for carry trades. That could mean that it could fall further during periods of risk-on sentiment and rally harder when fear returns and more shorts have to be covered, but longs will be deterred from holding it for too long as there is now a cost to doing so – in others words it may become more volatile.
Rather than domestic factors, Kuroda blamed problems in China, emerging markets, the oil price and financial market declines as reasons to unleash negative rates and are likely to be cut further if deemed necessary. And of course it all comes on top of the giant 80 trillion JPY annual qualitative and quantitative easing programme making a very bearish long-term case for the currency.
However, this latest move could heap pressure on China, which is trying to support CNY and is doing so by blowing its reserves whilst liberalising its financial markets. Imposing capital controls would somewhat go against the spirt of liberalisation. More details about China’s policies could emerge around Feb 26-27, when G20 finance ministers and central bankers meet in Shanghai.
China talks of shadowing a basket of currencies, no doubt including JPY rather than exclusively targeting the USD. However, if China did let CNY go and it fell heavily, it would likely create a storm in financial markets – ironically sending JPY higher while nerves are strained. In the meantime, South Korea, Taiwan and Singapore are no doubt contemplating their responses to Japan’s move, which could eventually include negative rates as they struggle to keep exports competitive.
Of course the ‘victim’ in this monetary policy merry go around will be USD – the one major currency where interest rates are increasing. The question though with just modest US growth and growing risks in the global economy, can the US Federal Reserve continue to afford to diverge so sharply from rival big currency blocks?
Looking ahead, the BoJ will probably further up the ante on stimulus measures along with the ECB this year out of desperation. And before 2016 is out market speculation could well turn to talking about rate cuts in the US, especially if the global outlook doesn’t improve in the coming months.
TECHNICAL ANALYSIS: USD/JPY – Rate cut impact could be short-lived
The BoJ’s negative rate move certainly delivered in terms of devaluing JPY versus USD – but the question is will it last, especially as market sentiment seems heavily geared towards prolonged periods of fear at the moment.
Indeed, negative rates are unlikely to undermine JPY’s ‘safe’ haven status during risk-off periods. If anything it has become more attractive as a funding currency to buy those with some yield, which tend to rise in buoyant conditions and fall when they become more adverse, which leads to short covering of the funding currency, namely JPY and EUR to an extent.
Following the rate move, USD/JPY spiked at 121.69, effectively creating a resistance level, followed by 122.56 and 123.38. However, in the last couple of days USD/JPY has been falling back with support likely to be encountered at around 120.40, 120.25 and 120.03. If 120.00 is successfully cleared away, then USD/JPY could very soon return to where it started before the rate cut at just below 119.00.
Given the prevailing mood music of negativity being played out by falling oil prices, China’s slowdown, volatile stock markets and global economic concerns – USD/JPY could soon retrace its losses.
However, the combination of quantitative easing and negative interest rates should support JPY long-term depreciation.
Nonetheless, on the dailies, the MACD still has a strong buy signal as do the daily slow stochastics – though the later could be moving towards giving a sell signal.
Among events to watch out for – BoJ governor Kuroda is due to speak tomorrow early morning and even more important, Friday sees the release of US Non-Farm Payrolls for January forecast at around 190,000-200,000 versus December’s exceptionally strong number of 292.000 with unemployment seen unchanged at 5%.
Any major deviation from those expectations could have an impact on US interest rate forecasts and USD crosses.
By Justin Pugsley, Markets Analyst, MahiFX