USDJPY I Forecast ahead of BOJ POLICY RATE 💰Welcome back! Let me know your thoughts in the comments!
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Bojexpectations
What Next For The Yen?In Karate, offense is the best form of defence. The BoJ knows it. Japan faces a raft of economic headwinds which shows up in Yen’s performance.
The BoJ intervened strongly last year to support the currency when it skirted around current levels. Yen is hovering at those levels again. BoJ is anticipated to act. Such interventions typically mark the bottom.
This paper explores recent economic data to analyse the potential for monetary policy changes by BOJ.
JAPANESE MACROECONOMIC CONDITIONS HAMPER YEN FROM STRENGTHENING
Starting September, the Yen has trended lower relative to the USD among currency majors.
The Yen has weakened the most. As described previously , BoJ’s aims to kickstart the economy onto a high growth trajectory to exit decades of painful deflation.
Recent macroeconomic data indicates weakness. This reaffirms the need for continued loose monetary policy. However, a frail Yen poses a different type of challenge for the BoJ with higher import costs for fresh food and fuel.
This leaves the BoJ in a predicament between loose monetary policy and intervention to support the Yen. What does recent inflation, GDP, and wage data point to?
Inflation
Inflation declined M-o-M in September. CPI cooled to 2.8% falling below 3% for the first time in a year. Importantly, Japan’s producer prices are now below 2% in a sign that inflation might have peaked.
Consumer prices will fail to prevail above 4% for long with input prices moderating. The BoJ expects inflation to persist until March next year at current levels and to cool towards target rates in the following 12 months.
GDP Growth
The Japanese economy shrank 2.1% YoY in Q3. This is far below expectations of 0.6% decline and a sharp slowdown from +4.5% growth in Q2. Slow economic growth makes economic stimulus essential to sustain it.
Wages
Nominal wage growth continues to decline. Real wages are even more concerning. Wages have declined for the last 18 months when adjusted for inflation.
Next Shunto negotiations are set to complete by mid-Jan 2024 with outcome remaining uncertain. The BoJ highlighted that wage uncertainties and price-setting behaviour pose upside risk to prices.
Meanwhile, high inflation will keep impacting real wages, affecting people's ability to spend.
THE BANK OF JAPAN IS STUCK BETWEEN A ROCK AND A HARD PLACE
At the October monetary policy meeting, the BoJ announced changes to the bond yield cap. The Yield Curve Control (YCC) policy and range were kept unchanged.
However, a small modification was made to change the 1% JGB yield cap from a rigid one to a loose reference. These changes hint at BoJ setting itself up for the eventual roll-back of the YCC policy altogether.
Next BoJ policy meeting is set for December 19th. The BoJ will likely maintain stimulus and hold rates low amid feeble consumer & business spending.
The policy change will be through YCC dismantling, impacting the JGB market. It will require careful planning and deft timing.
Meanwhile, the BoJ may intervene to stem continued Yen weakness. The officials have expressed this sentiment over the last two weeks via warnings for participants shorting the Yen over the past two weeks.
Japan’s Ministry of Finance (MoF) intervened three times last year, injecting USD 68 billion to support the Yen when it was trading near 150/USD. These interventions, unannounced, led to sharp and unexpected currency moves.
Unlike previous exchange rate-based interventions, the BoJ’s current predicament revolves around volatility and public perception.
Reuters reports that if Japan aims to prevent yen appreciation, the MoF will issue short-term bills to raise Yen, which is then sold in the market to weaken the currency. Alternatively, to curb Yen depreciation, authorities will tap into Japan's FX reserves, exchanging dollars for the Yen.
In recent weeks, Japanese authorities have issued warnings and expressed readiness to intervene as the Yen continues to weaken, despite a moderating USD.
Masato Kanda, Japan's top currency official, emphasized the urgency of their judgments and the potential for intervention, resonating with rhetorics used a year ago.
MIXED SIGNALS FROM CURRENCY DERIVATIVES MARKETS
Although asset managers are not positioned as net short as they were in late-September, they increased their net short positioning (weakening Yen) last Tuesday. Similarly, leveraged funds also increased net short positioning sharply last week.
Options markets contrarily signal strength in the Yen. P/C ratio for CME Japanese Yen Options (JPU) is 0.42 implying two puts for every five calls. JPUs are quoted with the Yen as the base currency so call options express a view of the Yen strengthening.
Moreover, bullish bets have increased heavily over the past week. Specifically, nearest monthly and weekly contracts (JPZ3 and WJ4X3) show Yen strengthening in the near term. Bullish bets in December options outnumber bearish bets by three times.
Although put open interest (OI) is concentrated near current levels with the highest OI at 0.0066 (151 in USD/JPY), call OI is more spread across with a large OI at strike of 0.0069 (145 in USD/JPY) which has ballooned over the last week. This signals that options market expects Yen strengthening by next month.
Finally, implied volatility on JPU is near its lowest level since March 2022.
Source: CME CVOL
Options skew on JPU is close to one, indicating that premiums on calls and puts are equally priced. Convexity remains elevated signalling investor interest in OTM options suggesting likelihood of sharp moves ahead.
HYPOTHETICAL TRADE SETUP
Given 12-month low implied volatility, a position in JPU can yield cost-effective protection against sharp Yen moves.
Alternatively, with the anticipated stability in Japanese interest rates, a short futures position in CME Japanese Yen futures, as previously discussed in a paper , is a viable approach to capitalizing on Yen's expected weakening. We can tap into JPU to safeguard this position against unforeseen risks of yen strengthening from BoJ intervention.
Furthermore, CME offers weekly options for Japanese Yen futures, expiring from Monday through Friday of the week. This enables investors to attain short-term exposure on a more focused scale, accompanied by lower premiums compared to monthly options.
A long call option position in JPUZ3 (expiring on December 8) would benefit from a BoJ intervention.
The trade setup consists of an entry at a strike of 0.0068 (JPY 147.0588) in JPUZ3 call options. These options are at a delta of 25 and expire in 30 days providing a good trade-off between low premium and adequate exposure to the underlying.
As of settlement on November 17th, premium for these options stood at USD 245 at an implied volatility of 8.26%.
Source: CME Options Calculator
The position breaks even at 0.00682 (JPY 146.6275) and turns profitable when (a) underlying futures price increases above strike price, and/or (b) implied volatility increases.
Source: CME QuikStrike
MARKET DATA
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GBPJPY | Will BoJ allow Diamond to shine? From technical point of view, we have clear Diamond pattern on a daily timeframe . As you can see on my chart, latest rally broke through the upper dynamic resistance, but got quickly pushed down while creating equal highs.
Market closed at a key lvl static support area and dynamic one , from Diamond formation. Based on just technical side, I'm expecting small correction to retest 182.080 , it is Camarilla long breakout pivot point. After possible rejection, price should move South and break below diamond pattern with possible move to Short breakout Camarilla point at 180.470.
But what about fundamental side? Well, Bank of Japan might overshadow other Banks in the upcoming week , if Ueda and other members decide to give us something unexpected. Due to experts, there is possibility for another YCC tweak, but I don't think it will be enough to support YEN to higher extend. Ex-BoJ member thinks that negative rates may stop by year-end, and that's exactly what we are looking for. Some word or single thought that could signalize potential end of negative rates. Carefully watch that meeting since it will be crucial.
And here we have Bank of England. BoE is expected to keep the Bank Rate unchanged at 5.25% . Everything will depend on narration of BoE's members. Pause + Neutral stance won't cause any sharp moves in my opinion.
Have a great day y'all! All the best
Why is the Bank of Japan nervous? ...To properly represent (and trade!) the Yen related pairs, it is strongly recommended to create a Yen-based currency basket. (I did attempt to import data into TV from such a basket - weighted by the acceleration differential between the USD, EUR, GBP, AUD, CAD, CHF and a basket of Central European currencies versus the Yen but for some reason I couldn't make that work. I.e., the main chart here represents the next best thing which is an unweighted USD|EUR|GBP|AUD|CAD / YEN basket, to convey the same idea.)
The central problem the Bank of Japan is facing at this moment, continued acceleration of rate (and thus, price) differentials relative to the other G-20 currencies. (I.e., The Yen price levels, alone, would not cause the same concerns.) On the top of it, China's PBC decided to dump massive amounts of Yen (and Euro) reserves, still actively taking place as of last Friday.
The now solid uptrend in Japanese economic indicators also continue to add to the upward pressures, leaving the BoJ with ever less wiggle-room.
FX Yen options implied volatility - 8.34%-8.93% - is running under historical levels, (i.e. they are considered "cheap") despite the increased Call buying, as of late.
Ultimately, what the BoJ will be forced to do here, and most importantly When(?) and to what extent, is still open to debate but two aspects of this issue became rather obvious;
1) At this point markets, in general, seem to maintain a complacent stance (see options pricing) regarding the significance and potential magnitude of a BoJ move;
2) This is a 30-year, $3+ Trillion Dollar short position which will have to be unwound (covered) in the event of a BoJ interest rate hike and as such, liquidity will be a major issue!
To illustrate the last point - above -, this was the recent EURJPY action following a rumor that the BoJ "may do something";
Yen's gains look cappedThe end of an era
The global stock of bonds yielding sub-zero yields has been erased at the start of 2023, after peaking at US$18.4Trn in late 20201. The fight over inflation has caused central banks from the US, Europe, UK and across the world to exit their low to negative interest rate policy. Even the Bank of Japan – the world’s last dovish monetary authority- has left the sub-zero club and is inching towards normalisation.
BOJ policy shift
The Bank of Japan (BOJ) unexpectedly widened its target range for the 10-year Japanese Government Bond yields (JGB) from ±25Bps to ±50Bps at its December 20th meeting. Since then, the surge in 10-year JGB yields has caused a sharp rise of additional fixed rate and fixed amount purchases by the BOJ amounting to ¥17Trn. Market participants are speculating that BOJ will be forced to tighten policy even more in 2023.
Political pressure alongside costly intervention forced the BOJ to tweak policy
In 2022 – despite the BOJ keeping the Japanese 0–10-year curve fixed, sharply rising yields globally led the Yen to depreciate to a 24-year low, thereby stimulating Japanese net exports. This placed direct upward pressure on Japanese inflation via higher import prices. Japan was no longer able to sustain its yield curve control policy against a backdrop of ever-rising global yields because the interventions it needed to make in its government bond markets to defend the rise in JGB yields were becoming too costly. In addition, pressure from the Kishida administration due to concern about Yen’s depreciation pushing up prices and inflicting further damage on cabinet approval ratings.
Yen gains look capped as policy framework likely to be maintained for longer
The change in policy prompted the yen to appreciate to ¥130 versus the US dollar, a level last seen in early August. The Yen’s current rally marks a sharp turnaround from last year where investors were shorting the yen owing to the widening interest rate gap between the US and Japan. As illustrated below, an unwind -63%2 in net speculative short positioning helped drive the appreciation in the Yen towards the end of the year.
If the BOJ were to make additional adjustments, it could spur further Yen appreciation. However, we feel the BOJ probably wants to keep its modified framework in place for a longer time frame, especially now that Yen versus USD stands at more comfortable levels. This was evident from its announcement of expansion of JGB purchases to ensure yields stay in the new range.
Signs that current inflation isn’t sustainable
The more concerning reason is wages are failing to keep up with inflation. In November, inflation adjusted pay slide 3.8% which was far worse than October’s 1.2% drop, marking the worst reading in 8 years3. 2023 wage growth depends largely on the results of annual spring negotiations between corporate management and labour unions. We expect bigger raises in base pay this year than in 2022, however its likely to keep up with inflation as the global economy slows.
Japanese economy could avoid a recession in 2023
Japan’s inflation is likely to remain low in 2023, resulting in less need to tighten policy further. Japan is likely to avoid a recession in 2023. As it has yet to benefit from the re-opening trade that the Western economies have witnessed over the last two years. Consumption is likely to benefit from the economic re-opening and capex intentions are likely to rise on the back of pent-up demand for goods and services.
While goods exports could soften due to the global economic slowdown, services exports are poised to steadily improve throughout the year, led by inbound spending following the lifting of border controls by the Japanese government in October 2022. The government also launched a new economic stimulus package in October to tame inflation and cushion the blow from rising raw material prices which should support the economic recovery in 2023.
Factors underpinning the resilience in Japanese equity market performance
In the face of the global equity market turmoil in 2022, Japanese equities4 performance has been fairly resilient (-11% versus -20%5 for global equities). Japan generates a large portion (nearly 52.7%6) of its revenues from global markets. So, a weaker Yen supported its profit outlook thereby making Japanese exporters more competitive than global peers. In 2022, a number of companies announced increased dividend pay-out ratios as well as share buybacks, with the intention of protecting shareholder returns amidst the global market volatility. Pay-out ratios rose to 63% from 40%7 at the start of 2022.
USDJPY: BOJ - FINAL THOUGHTS; FUNDAMENTAL/ TECHNICAL ANALYSISAt market price:
1. At 104 $yen offers an attractive buy and sell side - from the position of not knowing what the BOJ will do..
- I dont think that this pull-back to 104 is a material shift in risk-sentiment, rather i think this is a technical sell-off where the 107 pivot was hit (as highlighted) at which point BOJ/ UJ bulls lost confidence on their long positions which in turn caused a cascade of $Yen selling on profit taking - right into the 104 pivot. Also as you can see the price traded to 50% retracement of the risk-rally price (currently at 40%) after 4days - i dont consider this a fundamental risk-shift, such a shift would cause much more aggressive selling in fewer days e.g. 50% in 1-2 days, rather than 4 - this just looks like a technical pull-back and i wouldnt be surprised to see use move into the 105mids again. However, A break below 104 and I would agree that this is a BOJ market expectations move/ shift in risk sentiment to risk-off.
2. Most of you will know that I have been a $yen bull for some time citing policy divergence and future policy divergence as the reasoning.
- So this in mind, going into BOJ/ Fiscal stimulus, where policy divergence is likely to increase, how does this affect my bullish $yen view?
Bullish $Yen arguments:
1. The base case remains approximately 10bps to the depo rate, 10bps to the LSP, yen10trn to JGB and some 50-100% increase to the annual ETF from 3.3trn + the median expectation of stimulus is Yen15trn.
- So from a bulls perspective i wonder, how much of this move is already priced in, given the 5-6% move from 100/101 certainly wasn't for free - I think at the 106/7 level pretty much all of the base view is priced e.g. 10bps depo, 10bps LSP, yen10trn JGB increase and yen10-15trn of fiscal stimulus..
- Thus to make a position worth while imo the BOJ/ Fiscal Stimulus is going to have to outperform the median expectation. Imo in order to see 111 and for $yen to trade at such levels as an average for the next 3-6, we would have to see the base case almost doubled; e.g. 20bps to the depo, 20bps to the LSP, yen20trn JGB and perhaps yen20-30trn fiscal stimulus (which has been mentioned).
The case for BOJ beating expectations:
- I think the market is somewhat underestimating the BOJ/ Govt at only 6bps given the BOJ is seeing an already -0.4% deflationary environment (-0.5% in Tokyo) when - 1) Yen is up 20-30% in 2016 vs most ccys - which is even more deflationary, they need a big package to reduce this; 2) 9 consecutive months of exports falling aggressively - deflationary and a function of strengthening Yen - needs to be combated by aggressive easing policy to devalue the yen for sustained period; 3) No policy change since January - so they have had 6 months of policy transmission, where the situation has worsened, to see now something drastic is needed; 4) Brexit/ Fed hike/ US Election/ China/ other risk-off factors likely to drive yen further up in the future - thus preemptive action needs to be taken now; 5) Great Pressure from JPY Govt/ public given -0.4%CPI is the rate they had back in 2014 when they started the massive QEE programme - basically hasnt changed in 2yrs - BOJ underpressure for results; 6) BOJ knows markets are ready to sell any "average" easing - so they know they need to be aggressive to beat/ get infront of the marker; 7) BOJ knows its perhaps the last and best time to reclaim any market trust/ confidence - anything less than extraordinary and market will continue selling any future BOJ policy as they are already inclined to do - Since BOJ/ Kuroda confidence is low as they have failed to deliver on several previous big occasions e.g. April.
- If the above materialises I advise buying $Yen at market price, with a 109-111TP.