Yen: Journey from very undervalued, to undervalued – SocGen

Kit Juckes, Research Analyst at Societe Generale, suggests that the Abenomics relied on a weaker yen to boost inflation expectations and cut real interest rates, supporting corporate profits and asset prices enough to give the economy a fillip and buy time for structural reform to bear fruit.

Key Quotes

“But using a weak currency to push down real rates and boost inflation only works as long as the currency is weakening. Once it stabilised at exceptionally cheap levels, inflation expectations fell back and real rates rose. The yen lost a third of its value between September 2012 and June 2015, but by then it had fallen, in real terms, by between 20% and 40% against the other G10 currencies. Unable to fall any further, it actually strengthened marginally in 2015.

The result was that inflation expectations fell back and when the BOJ cut rates at the end of January, the currency didn’t react. Yen short positions started to be unwound and a strengthening currency dragged inflation expectations down, real yields back up. A vicious cycle has replaced the earlier virtuous one.

Enter Abenomics 2.0, which sees fresh fiscal easing, made possible by the fact that the BOJ has already bought a decent chunk of the government’s debt. That edges Japan closer to central-bank financed fiscal policy and raises the stakes – for the economy and the currency. If this latest throw of the dice delivers a sustainable acceleration in growth, the yen has scope to recover further, but the jury’s out.

For now, the USD/JPY and EUR/JPY are tracking real long-term rate differentials, though the EUR/JPY fall in recent days hints at a ‘Brexit’ premium on the yen. However, balance of payments data show significant long-term capital outflows from Japan which suggest that the yen’s bounce, at these levels, is overdone. We look for the USD/JPY to claw its way back above 110 in the coming months.”