JPY: Guided by politics, economics and defence spending - Rabobank

BoJ last month stated that inflation expectations remains in “weakening phase”, there would appear to be good reason behind Governor Kuroda recent statement that it was “too soon to discuss an exit plan”, according to Jane Foley, Senior FX Strategist at Rabobank. 

Key Quotes

“As it stands, this statement from Kuroda means that the BoJ could lag other G10 central banks in starting the policy normalisation process.  In theory this should disadvantage the JPY by triggering interest in the carry trade.  However, there are several reasons why the JPY is unlikely to give up too much ground vs. its G10 peers in the months ahead.  These are related to the JPY’s function as a safe haven.”

“On a one day view the JPY is one of the best performing G10 currencies.  The overnight sell off in risky assets and related demand for the JPY was a clear reaction to the news that N.Korea had successfully test-fired what could be an intercontinental ballistic missile which, after a reported 39 minutes, landed in the Sea of Japan.”

“According to PM Abe the launch “has clearly shown that the (N. Korean) threat has further increased”.  It puts into sharper focus the meetings that will take place at the weekend G20 summit between Abe, US President Trump and S.Korean President Moon Jaein on the topic of defence.  It also provides more context behind Abe’s ambition of changing Japan’s pacifist constitution ahead of the 2020 Olympic Games.”

“In 2015, Article 9 of Japan’s constitution was reinterpreted to allow Japan’s self-defence forces to assist allies, in particular the US, and therefore to potentially fight overseas.  In the April 2017 budget Japan’s defence spending was raised for a fifth consecutive year with expenditure set to rise by 1.4%.  While this rise is far smaller than the gains pledged by China and the US, a breach of the 1% level is nevertheless significant for a country which has been content to live with its pacifist outlook for 70 years.  PM Abe’s aim is to revise Article 9 by keeping the two existing clauses that  denunciate war as a means to solve conflict but to add a third clause that will unambiguously legitimise the constitutional status of Japan’s Self Defence Force.”

“Since the start of this year safe-haven demand for the yen has been impacted by events related to N.Korea on a handful of occasions.  Tensions with China over issues relating to territories in the S.China Sea has also impacted the value of the JPY.  Due to their proximity, and lack of resolution, these events may have had a more marked impact on the yen.  However, the yen’s safe haven appeal stretches further with current political uncertainty in Qatar another factor which could lend the yen support.  If the rise in defence spending in Japan, China and the US and Nato countries is indicative of geopolitical risk, safe haven demand is likely to continue limiting scope for the carry trade to pressure the yen lower going forward.  We expect USD/JPY to remain mostly in a 109 to 114 range in the months ahead with the ebb and flow of safe haven demand likely to continue to providing a strong influence.”