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08.05.2019 10:06 AM
USDJPY: the yen is preparing to leave the trading range

The threat of the worsening trade war between the United States and China has led to massive sales in stock markets. The US S & P 500 decline 1.7% to 2,884 p. The Shanghai Composite is trading around two-month lows, losing more than 9% in just 3 trading sessions and falling to 2866.7 p. The indices of Asian countries are falling at a faster pace, for which the degree of risk from possible problems in the Chinese economy, is higher than for the rest of the world.

Thus, threats to China increase the likelihood that the US will apply new experience in achieving its political goals to Europe, by increasing import duties on cars of European companies. As a result, nervousness is growing, forcing investors to switch attention to the defensive assets, which traditionally include the Japanese yen.

After two months of decline, the PMI in the manufacturing sector in Japan showed an increase to 50.2 p. Despite the retracement, the volume of the new orders and production continue to decline, and growth, in fact, is due only to increased business confidence, which is based on recently released optimistic forecasts for the semiconductor and automotive sectors of the economy.

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Nikkei comments are cautious and hints at the risks of renewed stagnation in the near future.

For more than two years, the Japanese yen has been trading in a narrow range of 104 - 114 yen per dollar, which is generally uncharacteristic of this generally volatile currency. The reasons why the yen lost its increased volatility follow from the changes that the Bank of Japan has made to its monetary policy, starting a large-scale program in 2013 to find a way out of the deflationary impasse of the Japanese economy. This program has not reached its goals, but has led to the creation of a stable picture of financial flows. The direction of which, in fact, determines the dynamics of USDJPY.

In its recent comments, the Bank of Japan acknowledges that the experiment of significantly easing monetary policy has reached its limit. The inflation forecasts from BoJ for this period up to 2020 remain well below the target of 2%, and there is no reason to expect that they can be adjusted upwards, since the structural changes in the Japanese economy does not give any reason. These factors include, for example, a persistently negative trend in land prices, or the growth potential of the economy as a whole.

At the same time, negative effects accumulate. The reduction of interest rates to negative levels has led to a steady decline in banks' investments in Japanese government bonds amidst the gap between deposit growth and loans.

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The growth rate of deposits significantly exceeds the growth rate of loans, and surplus funds in Japan itself with negative rates have nowhere to invest. As a result, Japanese banks are increasing their investments in foreign assets to compensate for falling revenues.

Thus, a balance of several counter-flows is formed. In addition, Japanese investors are increasing investment in US Treasures, as well as T-bills in France and Italy. The Bank of Japan also notes that as of February 2019 (March data will be published on May 14). Investments in corporate bonds are growing, and there are Japanese banks and funds looking for profitability anywhere, but not in Japan itself, which increases the risks. In this case, Japanese bonds are forced to buy the Bank of Japan, which already owns half of all sovereign debt.

As a result, the negative effects accumulate more and more, but there is still no benefit. The deflationary thinking could not be changed, and the tools are almost exhausted. These considerations push the yen to further weaken, since the withdrawal of investment capital is only increasing. Nevertheless, an upward exit from the range 105 - 115 is more likely in the long term.

Meanwhile, in the short term, the yen has every chance to test the strength of the March minimum at 109.70 and go lower to 108.49, which is facilitated by the approach on Friday, when the US can impose increased duties on Chinese imports. The probability of a stock market collapse contributes to the growth of panic and the demand for defensive assets, among which the yen comes first.

Kuvat Raharjo,
Analytical expert of InstaForex
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