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Analysis: Trump gives the BOJ exactly what it needs

  • November 17, 2016
  • , Nikkei Asian Review , 6:30 p.m.
  • English Press
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By Isaya Shimizu, Nikkei senior staff writer


TOKYO — The yen is rapidly losing its value against the dollar. This week, it fell into the 109 range against the greenback for the first time in five and a half months. Before the U.S. presidential election, the yen was around 103 to the dollar. Its big fall has forced analysts to adjust their currency projections.


Deutsche Bank said in a report dated Tuesday that it no longer expects the dollar to continue weakening against the yen. The bank now expects the dollar to be worth 115 yen at the end of next year.


If Deutsche Bank is right, Japanese exporters would get a huge lift.


The yen is under selling pressure thanks in part to expectations for Trumponomics, a series of economic stimulus measures suggested by U.S. President-elect Donald Trump. The policy menu includes tax cuts, infrastructure investment and deregulation. Investors believe Trump’s economic policies will spur U.S. economic growth.


This is fueling speculation that the Federal Reserve will be able to smoothly raise interest rates, pushing up both the yield on 10-year Treasurys and the dollar.


But the weaker yen is also a result of the Bank of Japan’s new monetary easing policy, introduced in late September. Under its “quantitative and qualitative monetary easing with yield curve control,” the central bank aims to guide the yield on the benchmark 10-year Japanese government bond to “around 0%” by adjusting its purchases of JGBs.


By pegging the long-term interest rate at near 0% — something the bank had never done before — the BOJ hopes to prevent the 10-year yield from chasing its U.S. counterpart higher. As a result, the gap between the two rates has been widening ever since Trump won the U.S. presidential election on Nov. 8.


And it is prompting traders to buy dollars.


Although the yield on the benchmark JGB has also been rising lately, a yield that could potentially reverse the current dollar-buying trend would trigger BOJ intervention.


QQE needs confidence


“This framework starts really working when the economy picks up,” a BOJ official said after the bank launched the new QQE program back in September. The thinking behind this is twofold.


One theory is that when U.S. interest rates go up on expectations for an economic recovery, as they are now, the U.S.-Japan interest rate differential will widen due to the BOJ’s 10-year yield peg. This creates strong downward pressure on the yen, which in turn pushes up prices.


The second is that, under the program, improved market conditions will likely trigger a mechanism that reinforces people’s inflation expectations. Under the new QQE program, the BOJ promised to continue expanding the monetary base until the pace of price increases exceeds and remains above 2% in a stable manner. The BOJ calls this its “inflation-overshooting commitment.” This “bold commitment,” as described by BOJ Gov. Haruhiko Kuroda, is designed to stoke inflation expectations.


But this strategy does not work well unless people have at least some sense that prices are going to rise. When nobody expects prices to rise, the BOJ’s QQE does not look so “bold.” When prices finally start rising on the back of a weaker yen, the “overshooting commitment” is more likely to have its desired effects.


Trump’s victory has put the markets in risk-on mode, opening a way for the new QQE to come into its own. If this can be sustained, Japan’s economy can expect a strong boost.


However, there is still danger ahead that could weigh on the dollar. “If the dollar becomes too strong, key members of the Trump administration may express concern,” JPMorgan Chase Bank’s Toru Sasaki said. For now, all eyes are on a meeting between the president-elect and Japanese Prime Minister Shinzo Abe, now only hours away.


Furthermore, if emerging market currencies lose further ground, eroding investor confidence, the yen may start strengthening as a haven currency. Also, analysts remain skeptical as to where Trump might find the money to finance tax cuts and pay for other economic measures. Fears of a widened fiscal deficit could sap the dollar’s strength.


QQE prone to strong yen


For this reason, the BOJ has not lowered its guard. The new QQE is, despite its strength in times of favorable market conditions, vulnerable to a stronger yen; it leaves little room for additional easing.


For example, the short-term rate, charged to some of the money commercial lenders keep with the BOJ, currently sits at minus 0.1%. Taking it deeper into negative territory would be akin to hiking a tax. This would eat into profits and cause bank shares to be sold.


Lowering long-term rates, meanwhile, would hurt returns on capital held by insurance companies, pension funds and other big institutions that keep the economy going. This could scare off investors.


“I will follow the markets closely,” Kuroda said on Monday.


How long the risk-on mood brought by Trump’s victory can last is a big concern — not just for investors but for the central bank, too.

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