A Retreat in USD/JPY: real reversal or just a correction?

Outlook:

The news today in the US includes the ADP forecast of private sector payrolls.
Reuters reports the forecast of the forecast is 195,000 jobs in Jan, less than the whopping 257,000 in Dec but not a bad number. We also get the EIA oil inventory number today after the API estimated a build of 3.8 million barrels that was at least partly to blame for the drop in oil prices yesterday. Finally, the non-manufacturing ISM index is likely a dip to 55.1 in Jan from 55.3 in Decem-ber.
We are appalled by the press reports on negative yields. In the US yesterday, the yield is now lower than any time since April 2015. The Bund fell to 0.308% this morning and the FT reports the 2-year at -0.48%. The Japanese 10-year went to a low overnight at a record low 0.045%, with today’s auction can-celed lest it go into negative territory. But it seems inevitable and it also seems the BoJ accepts it.
“Analysts already expect positive yields may not last long. Deutsche Bank is forecasting 10-year JGB to trade in a range of negative 0.05 to positive 0.15 percent for the time being. Capital Economics tips the bond yield to fall to negative 0.25 percent by the end of this year.

“However, a yield below zero on 10-year bonds is rare. Switzerland 10-year bonds currently yield neg-ative 0.28 percent although the country's bond market is smaller than Japan's.”

Negative returns on the benchmark note will not necessarily drive Japanese fixed income managers into riskier assets—or overseas. After all, Japanese are famously risk averse, especially when it comes to for-eign assets. The BoJ may be laying a dud egg.

Now turn to the US, where some analysts (such as JP Morgan) called for the Treasury to cut back the size of today’s issues by a billion in each tranche for the next three months—to avoid negative rates.
Bloomberg has a scare story on rates going negative in the US, noting that the Fed included a negative 3-month rate in the latest bank stress test for 2016, announced last week. This would be just one of many possible scenarios, of course. Bloomberg notes “Three-month bill rates have slipped slightly be-low zero several times in recent years, including in September after the Fed delayed rate liftoff amid global financial market turmoil, touching a low of minus 0.05 percent on Oct. 2. But in the stress test, banks would have to handle three-month bill rates entering negative territory in the second quarter of 2016, and then falling to negative 0.5 percent and holding there through the first quarter of 2019.”

Remember, it’s not a forecast, it’s a scenario. But Bloomberg likes to stick the knife in. “New York Fed President William Dudley said last month that policy makers were ‘not thinking at all seriously of mov-ing to negative interest rates "But I suppose if the economy were to unexpectedly weaken dramatically, and we decided that we needed to use a full array of monetary policy tools to provide stimulus, it’s something that we would contemplate as a potential action," he said on Jan. 15.And on Monday Fed Vice-Chair Fischer said that negative rates “… is working more than I can say I expected in 2012.”

Offsetting the nightmare scenario is Kansas City Fed Pres George, who says turmoil is not really a sur-prise and not a reason to derail the Fed’s rising rate plan. “While taking a signal from such volatility is warranted, monetary policy cannot respond to every blip in financial markets. The recent bout of volatil-ity is not all that unexpected, nor necessarily worrisome, given that the Fed’s low interest rate and bond-buying policies focused on boosting asset prices as a means of stimulating the real economy.”
George says the US is resilient in the face of global headwinds. And waiting for forecasted outcomes might mean we waited too long. We have to work with forecasts.
Right now it seems unthinkable the US would or could also go to negative rates. As the FT points out, negative rates are something that did not exist 18 months ago. “In mid-2014, there was no such thing as negative-yielding bonds: government debt securities that trade at such a high price that a buyer would make a loss by holding them to maturity. Now, negative yielders account for one-quarter of the entire government bond universe. On Monday, there were even more of them, as markets felt the effect of Japan’s surprise easing last week.”

The BoJ’s Kuroda was wildly bold, saying there is “no limit” to monetary easing and he would invent new tools rather than give up the inflation target. The FT reports “Going forward, if judged necessary, it is possible to cut the interest rate further from the current level of minus 0.1 per cent,” said Mr Kuroda, pointing to the Swiss National Bank at minus 0.75 per cent and the Riksbank at minus 1.1 per cent, as examples of what the BoJ could do.” Kuroda also said “It is no exaggeration that [ours] is the most pow-erful monetary policy framework in the history of modern central banking.”

This is a “holy cow!” moment if ever there was one. Assuming the analysts are right that the risk averse Japanese managers will just keep buying notes at any rates, including negative ones, this leads after only a short time to impoverishment of pension funds, among other awful outcomes. Foreigners won’t want Japanese government paper unless they are playing the FX card.

What we really want to know is whether the retreat in the dollar/yen is a real reversal or just a correc-tion. How can a negative yield be anything except an invitation to new carry trades? It’s already screw-ing up our understanding of the Swiss franc chart. As in the Swissie, we can probably expect some jig-gling and backing and filling, but a confused picture overall. Can a currency still be a safe-haven with negative returns? You’d have to be really scared.

Now is not the time to be taking any positions in FX. We hate to admit it, but the dollar is a coin-toss today. We can imagine equally plausible scenarios in either direction. On the whole, we favor the nega-tive dollar outcome, if only because historically, that’s the normal outcome.