Despite solid gains in US and European markets over the past few months that Asia heavyweight Japan has enjoyed rather limited luck with even the BoJ’s efforts to continue on the central bank easing bandwagon given short shrift by the market. The performance of the JPY specifically must be worrying for Japanese officials, particularly its unresponsiveness to the ‘risk on’ mood which in the past has provided exporters with some much needed breathing space. Indeed, USD/JPY has been stuck sub 80.00 throughout Q3, in stark contrast to price action in Q1 where a similar ‘risk on’ phase was enough to push the pair up around eight big figures back towards 84.00. The implications if the mood shifts don’t look particularly encouraging with this in mind, particularly given the ineffectiveness of the BoJ’s preferred tools of verbal then physical intervention to contain unwarranted/undesirable JPY appreciation.
However, that’s not say Japanese policy makers do not have options to try and soften the currency, as we wrote at the beginning of September 2011 in our piece “Where the Swiss tread will others dare to follow? PM Noda!” the SNB’s adoption of a peg to curtail CHF appreciation should certainly be a line of enquiry for a number of reasons and the case is now even clearer thanks to the Swiss experience over the past 12-months or so. Proof of concept if you like as well as rough guide to potential costs. We actually think such a solution would reap far more benefits from a Japanese perspective, potentially offering an effective route to tackle the deflationary mind-set which has become so entrenched. This is proving very difficult to dislodge currently, oblivious to the BoJ’s 1% inflation target for example, and we think this stickiness is also highly relevant to the FX level, creating expectations of a stronger JPY which not only deters corporates in making overseas investments and acquisitions but also deters private investors from diversifying into offshore assets, the perception being they will only get cheaper. More simply, Yen strength like deflation itself is now something of a self- fulfilling prophecy and this is unlikely to change voluntarily. One event that logically ought to have encouraged investors to spread their risk, the Fukushima incident, actually seems to have had the opposite effect, encouraging repatriation (the national unity effect).