JPY has been the biggest beneficiary from the recent USD-selloff among the major currencies. Several factors seem to have contributed to the rally on the flow side. Hedging flows from the Japanese exporters likely intensified when USD/JPY broke below the corporate budget rate at around 118. Steady outflows out of the Japanese equity markets also forced investors to unwind short-JPY hedges whereas the latest sharp repatriation flows into Japan seemingly went hand in hand with the JPY bounce in recent days. Investors doubt that the Japanese officials have any tools left to lean against FX appreciation. There doesn’t seem to be much scope for further rate cuts given the risk that the domestic banks may pass on the penalty rate onto their depositors. The resulting negative wealth effect could be a drag on growth and derail the recovery.
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In addition, an official FX intervention remains less likely for now given that JPY NEER and REER still looks undervalued. We estimate that USD/JPY will have to drop much closer to 100 to correct most of its current overvaluation and thus strengthen the case for potential official action. One should also consider the 2013 G20 communique which saw scope for official involvement when market moves are particularly disruptive and fuel asset price volatility. Both FX and stock market implied volatility are well below their recent highs, however, and we conclude that the case for an intervention remains weak for now.
The above being said, we still believe that the BoJ can ease further from here. In particular, we expect the BoJ to announce direct purchases of Japanese stocks and send a strong signal that it is keen to expand its balance sheet for many quarters ahead. While our call is for the new policy measures to be announced in June, further intensification of the selloff in USD/JPY and the Japanese stocks could force the BoJ to front load the measures to its meeting on April 28. We expect the new asset purchases program to encourage renewed foreign inflows into the Nikkei market, accompanied by fresh JPY-selling on the hedge. The purchases could further encourage renewed outflows of excess savings from Japan.
The BoJ measures should ultimately hold the JPY-rally in its tracks. With the outlook for market risk sentiment still fairly uncertain, however, and the Japanese growth outlook still uncertain the hedged inflows into the Japanese stock market may fall short of recent QE episodes. By the same token, portfolio outflows out of Japan need not pickup aggressively so long as investors remain risk averse. In addition, FX spot still well below the corporate budget rate and that may encourage further JPY buying by exporters. All that could suggest that the JPY downside on the back of BoJ easing could be less pronounced in the immediate aftermath of the measures.