The yen has weakened off by around 11.5% against the euro in
the past two months. This is largely attributable to the convergence of
performance between the US and Japan economies and monetary easing from the
Bank of Japan.
The Japanese economy remains a key underperformer among the
major global economies; it contracted by 0.2% in the final quarter of 2012
(though this was revised up from an initial estimate of a 0.6% contraction).
Reduced exports, caused by the yen’s excessive strength and weakening global
demand, are a key factor weighing on Japanese growth. However, industrial
production and the post-earthquake reconstruction project is gaining pace,
which should take Japanese back into positive territory this quarter.
The market was recently dealt a scare by January’s Japanese
current account data, which revealed a record deficit of $5.41bn. The yen
suffered as a result – Japan’s current account surplus has been a cornerstone
of the JPY’s safe-haven status. Nonetheless, it remains likely that this
deficit will prove a temporary blip, though it did the yen no favours in the
The US economy, by contrast, is out performing. It grew at
an annualised pace of 3.0% in the final quarter of 2011. As shown by the
Non-Farm payrolls figures so far this year, the US labour market is making some
real improvements. Crucially, this has seen the US Federal Reserve remove any
reference to QE3 from its messages and in a statement this week, it upgraded
its economic outlook from “modest growth” to “moderate growth.” With China
slowing down, the eurozone entering a recession and Japanese growth likely to
be fairly flat this year; the US economy is the real outperformer at present
and we are seeing considerable yen to dollar flows as a result.
Another key factor weighing on the JPY is the Bank of
Japan’s commitment to yen-depreciation. The strong yen has been a huge downside
factor on Japanese exports. The Bank of Japan has repeatedly failed in its
attempt s to directly intervene in the currency markets but monetary easing is
still a weapon that the market is wary of.
February saw the BoJ boost its quantitative easing programme
by 10 trillion yen, which has fuelled much of EUR/JPY’s gains in the past
month. Whilst the BoJ took no further major action at its March meeting,
the dissent within the committee highlights the scope for further easing. The
Bank of Japan is highly concerned with the country’s deflation problem and is
likely to continue monetary easing this year in order to achieve its 1.00%
There are a plethora of reasons why not to invest in the
euro this year. Having contracted by 0.2% last quarter, the eurozone’s growth
figures in the year so far are pointing quite clearly to a recession.
Nonetheless, there have been some broadly positive developments out of the eurozone
in recent weeks, with the Greek debt-swap deal going through and paving the way
for what is likely to be a second Greek bailout. However, sentiment towards the
euro has been hit hard, as shown news by the 13.5% decline in the EUR/USD pair
from last summer’s high.
Greece will be granted aid for now but it is widely expected
to return to bailout territory by next year. Market sentiment remains
suspicious that Portugal and more alarmingly Spain and Italy may be forced to
follow a similar path in having to restructure their debt. The only real factor
seemingly supporting the euro at present is the constant need of Asian and
Middle Eastern central banks to diversify their FX reserves away from the US
Regardless of the eurozone’s poor growth and debt dynamics,
monetary policy in Japan is likely to be the dominant driver of this pair in
2012 and EUR/JPY’s rise will not be a symptom of euro strength but of yen
weakness. Long positions in the yen have fallen back considerably from
January’s highs and we do not view the weakening bias we have seen in the yen
in the past few to be temporary.
Developments in the eurozone and the US economy have
provided a boost to global stocks, including the Nikkei, and in these risk-on
conditions the safe-haven yen will always weaken. Events in the eurozone are
likely to put plenty of pressure on market risk appetite this year but our bet
is that the BoJ will successfully demonstrate its resolve in weakening the yen
through monetary easing, something it failed to do through direct intervention.
We can see the EUR/JPY rate continuing its uptrend from the
current 109.00 level in the coming months. This should see April 2011’s highs
above the 120.00 level revisited at some point in the second half of this year.
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