Japan, FED and High Yield Emerging Markets




USDJPY has rallied 1% today as the BoJ kept the policy rate unchanged at -0.1% but opted for a new strategy of steepening their yield curve via designated yields of purchases of JGBs, titled “QQE with Yield Curve Control”. So far the equity markets have taken the policy well too with the Nikkei rallying 2% and the Topix Banks index up over 6.8%. The monetary base target, previously increasing by JPY80trn a year, could now fluctuate in the short term in theory as policy makers adjust their JGB purchase amounts to yield levels and look at liquidity constraints. In the near term while this could mean short term fluctuations in the Monetary base, we don’t expect that to have a large impact on USDJPY as the annual target is kept at the same pace. On top of this we think USDJPY is influenced by the shape of the curve and less on level of yield for now. The BoJ providing new forward guidance saying that they plan to expand the monetary base until CPI exceeds 2% is similar to the rhetoric from the ECB. We reiterate our view that the JPY would only weaken if inflation expectations rise.

The BoJ will no longer try to maintain an average maturity of purchases of 7-12years,allowing them flexibility on what they buy. This strategy could push some purchases out of the back end of the curve and towards the front end which should aid bank profitability and thus risk appetite. Note that the BoJ had already changed some of their purchases from June to July, decreasing 20 and 30y purchases and putting them into the 5y and 10y part of the curve. The BoJ will aim to keep the 10y JGB yield anchored at around 0%. The impact on the JPY depends on the risk taking ability of the banking sector. Up until now, low interest rates have expanded base money (M0) but this has not trickled through into a larger credit creation by banks to support the corporate sector and thus growth and inflation. BoJ will continue to purchase equity ETFs but allocate less to the Nikkei and more to the Topix which is supportive for the equity markets and feeds through into a weaker JPY if this is generally risk supportive. The JPY would weaken if the banking sector opts to lend more outside of Japan or invest into (now)higher yielding lending domestically.
The BoJhas shown today they are they are not completely out of monetary policy tools but for the JPY to weaken lastingly it is has to be supported by fiscal policy. Fiscal expansion funded by long maturity debt can change the mindset of participants within an economy, meaning they may no longer assume current fiscal spending is going to be supported by tax increases. This type of policy should steepen the JGB yield curve and weaken the JPY only if inflation expectations rise.

Our expectation is for a dovish Fed to bring down the dots for the coming years but leave the door open for a December rate hike. In particular our economists expect median to move down to 1 hike in 2016, 2hikes in 2017,3in 2018,and 4 hikes in 2019 for a terminal rate of 3%. This combination should be sufficient to weaken the USD, focusing on the high yielding EM and AUD and NZD, with rangebound activity against low yielding currencies. The currency pairs most prone to weakening immediately are likely those where long USD positions have gathered over recent days. Taking the spot relative to the 50 and 100 day moving average, USDMYR seems the furthest stretched, followed by USDPHP. Within G10, GBP and CAD stand out. So far the USD has failed to break through the July high, supporting our view for it to weaken by a further 3%.