The yen: what drives further weakness versus a reversal.

Thinking through JPY drivers after getting banged over the head by JPY weakness.
The JPY sell-off followed through with surprising vigor, almost on a scale that suggests some see parallels with the arrival of Abe back in late 2012, who promised a sweeping new “three arrows” Abenomics agenda of monetary easing and fiscal reforms. But what a world of difference between the disinflationary zero-rates world backdrop of the time, with USDJPY at below 80. Compare that to the present day, when monetary policy tightening is on the agenda and we have a 50% devaluation in the JPY versus the US dollar. Meanwhile, the number one concern of Japanese voters is inflation and getting it under control.

If we recall back to the policy mix that was actually delivered by Abenomics, it was chiefly a sales tax hike on the fiscal side that came in 2014, while the real radical, big fat single “arrow” was a radical monetary easing, putting “Kuroda-nomics” (Kuroda was BoJ governor) in the driver’s seat. Around the same time – until well into 2014, the euro was uncomfortably strong because the ECB had yet to do proper QE, while US long treasury yields were all over the map – supporting the massive re-rating higher in USDJPY in 2013 as they spiked on the ”taper tantrum” of May-June before easing lower later.

So what now? At these levels, JPY sellers are anticipating that the Japan will continue to pursue financial repression and even yield-curve-control to prevent bond yields from pushing anywhere near the inflation level at the front end of the curve and perhaps out to 10-years. Meanwhile, Takaichi is seen pursuing a more fiscally aggressive policy, driven more by encouraging investment and targeted tax cuts than new spending. It’s a supply-side agenda that would normally be currency positive if it wasn’t for the concerns of fiscal stability and/or the monetary policy mix and significant carry differential between the JPY and other major currencies.

Taking the Occam’s razor approach here: the JPY weakening is helped along by carry trading as the market is encouraged to believe that a Takaichi government will encourage a strong boost to the economy and Japanese industry and Japanese stocks. At the same time, the BoJ and MoF will ensure that bond yields are kept low – encouraging inbound investment into Japanese stocks, flows that are cheap to hedge because of the low-yielding JPY.

This is a far more benign interpretation than the risk of some “Liz Truss moment” driven by concerns that Japan’s fiscal stability in question and must be transferred to the currency if the BoJ and MoF strong-arm the JGB market to suppress yields. What makes the JPY go stronger, then? First, there is the risk that Takaichi can only piece together a weak coalition that fails to deliver a more powerful policy response. But the only real sustained strong JPY scenario might require both deflation in global risk assets and a rally in global bond markets.

Chart: USDJPY
USDJPY tested marginal new highs above 153.00 after the strong momentum break above 150.00 and 151.00. It’s unwise to stand in front of an onrushing train, so let’s see how this one plays out – key to get the first policy signals and measure the level of concern this is likely already generating within the Ministry of Finance and at the Bank of Japan. Little to guide us on technical besides round numbers like 155.00, with some two-way volatility seemingly inevitable once officialdom weighs in.