JPY Fundamental Analysis: Five Months of Yen Weakness, Five Weeks of USD/JPY Uptrend, BoJ July Meeting Holds the Key (June 20)
Monday, 17 June, Week 25: The Japanese yen has been on a weakening trend for the past five months, driven by a combination of factors including the Bank of Japan's (BoJ) ultra-loose monetary policy, a widening interest rate differential with other major economies, and safe-haven demand for the US dollar amid geopolitical risks. Over the past five weeks, the USD/JPY has been on an uptrend, rising from around 155 to above 157. This report will delve into the key market fundamentals affecting the Japanese economy, monetary policy, and the yen, providing insights into the potential direction of the currency in the coming weeks. The BoJ's July meeting, where the central bank is expected to release a plan on winding down its bond-buying program, will be a pivotal event for the yen's trajectory.
Fiscal Policy
Japan's fiscal policy remains expansionary, with the government aiming to support economic growth and address social challenges such as the declining birthrate and the impact of the 2024 Noto Peninsula earthquake. The FY2024 draft budget outlines a plan to reduce new government bond issuance while sustaining expenditure reform initiatives and normalising expenditures structurally. The government is prioritising "wage increases that overcome price hikes" to stimulate a virtuous economic cycle. To this end, the budget includes provisions for pay-scale increases for healthcare and welfare workers, nursery teachers, and teachers at public elementary and junior high schools. The government is also implementing measures to support small and medium enterprises (SMEs) in raising wages, including a labour-saving investment support program and a business improvement cost support program.
The government's commitment to fiscal consolidation is evident in its efforts to improve spending efficiency and reduce reliance on bond issuance. However, the ongoing need for disaster relief and reconstruction spending, coupled with the expansionary measures aimed at boosting wages and supporting families, will likely keep fiscal policy accommodative in the near term. Over the next five weeks, the focus will be on the implementation of the FY2024 budget and the government's progress in securing financial resources for its ambitious spending plans. Any signs of fiscal slippage or a lack of progress in expenditure reforms could weigh on the yen.
Economics
Economic Growth
Japan's economy has been recovering moderately, although some weakness has been seen in part. The latest data shows that Japan's GDP contracted by 0.5% quarter-on-quarter in Q1 2024, reversing from an upwardly revised 0.1% growth in Q4 2023. Private consumption, a key driver of the economy, fell for the fourth straight quarter, marking the steepest fall in three quarters. This weakness in consumption reflects the impact of elevated price pressure, tepid wage growth, and the impact of the earthquake on the first day of the year. However, net trade was a drag on GDP, subtracting 0.2 percentage points as exports slipped more than imports.
Looking ahead, the BoJ expects the economy to continue growing at a pace above its potential growth rate, supported by continued growth in overseas economies and a gradual intensification of the virtuous cycle from income to spending. However, the outlook remains uncertain, with risks stemming from developments in overseas economic activity and prices, commodity price fluctuations, and domestic firms' wage- and price-setting behaviour. Over the next five weeks, key data releases to watch include the June 21 Flash PMIs, which will provide insights into the health of the manufacturing and services sectors, and the June 21 CPI data, which will shed light on inflationary pressures.
Labour
Japan's unemployment rate remained unchanged at 2.6% in April 2024, holding steady for the third straight month. The labour market remains tight, with the jobs-to-applications ratio falling to 1.26 in April from 1.28 in March. The government's efforts to promote wage increases are aimed at addressing labour shortages and boosting consumption. However, the impact of these measures on wage growth remains to be seen. The June 27 unemployment rate release will be closely watched for signs of improvement in wage dynamics.
Price Changes
The annual inflation rate in Japan fell to 2.5% in April 2024 from 2.7% in March, moderating for the second straight month. The core inflation rate, which excludes volatile food and energy prices, also dropped to 2.2% from 2.6%, matching market forecasts and pointing to the lowest print since January. The BoJ expects underlying CPI inflation to increase gradually, driven by an improving output gap and rising medium- to long-term inflation expectations. However, the central bank acknowledges that "there remain high uncertainties surrounding Japan's economic activity and prices, including developments in overseas economic activity and prices, developments in commodity prices, and domestic firms' wage- and price-setting behaviour." The June 20 CPI data will be crucial in assessing the trajectory of inflation and its implications for monetary policy.
Trade
Japan's trade deficit increased to JPY 462.50 billion in April 2024 from JPY 429.79 billion in the same month of the prior year. Exports grew by 8.3% year-on-year, the fifth straight month of growth, but less than forecasts of an 11.1% jump. Imports also expanded by 8.3%, the strongest growth in 14 months. The widening trade deficit reflects the impact of higher import costs, particularly for mineral fuels. The June 18 trade balance data will provide further insights into the dynamics of Japan's external sector.
Monetary Policy
The BoJ maintained its ultra-loose monetary policy at its June meeting, keeping the key short-term interest rate at -0.1% and continuing its bond-buying program at the current pace. However, the central bank signalled a potential shift in policy at its July meeting, indicating that it may consider how to start reducing bond purchases. The BoJ's statement acknowledged that "Japan's economy has recovered moderately, although some weakness has been seen in part" and that "underlying CPI inflation is expected to increase gradually." However, the central bank also highlighted the "high uncertainties surrounding Japan's economic activity and prices."
The BoJ's decision to maintain its accommodative stance in June reflects its cautious approach amid lingering economic uncertainties and its desire to support the government's efforts to boost wages and inflation. However, the signal of a potential policy shift in July suggests that the central bank is becoming more confident in the sustainability of the economic recovery and the outlook for inflation. The July meeting will be a pivotal event for the yen, as the market will closely scrutinise the BoJ's plan for reducing bond purchases and its assessment of the economy and inflation. Any signs of a hawkish shift in policy could trigger a significant appreciation of the yen.
Geopolitics and Market Themes
Several geopolitical situations and market themes are influencing the Japanese economy, monetary policy, and the yen.
Israel-Hamas Conflict
Synopsis: The ongoing conflict between Israel and Hamas is contributing to heightened geopolitical risk aversion, supporting safe-haven assets like the US dollar and weighing on risk-sensitive currencies like the yen.
Key Developments:
Israel's military has announced a daily tactical pause in operations near a crossing into Gaza for humanitarian purposes.
Hamas leader Ismail Haniyeh has stated that the group's response to the latest Gaza ceasefire proposal aligns with the principles of US President Joe Biden's plan.
Hezbollah has launched a barrage of rockets into northern Israel in retaliation for the killing of a senior commander by Israel.
The White House has announced that Qatar and Egypt plan to hold talks with Hamas regarding a Gaza ceasefire.
Market Impact:
The conflict has contributed to a flight to safety, boosting the US dollar and weighing on the yen.
Concerns about potential disruptions to oil supplies from the Middle East have supported oil prices, which could have a negative impact on the Japanese economy, a major oil importer.
Political Uncertainty in Europe
Synopsis: Political instability in Europe, particularly in France, is weighing on investor sentiment and the euro, indirectly supporting the US dollar and putting pressure on the yen.
Key Developments:
French President Emmanuel Macron has dissolved the government following the National Rally's strong performance in the EU parliamentary elections.
The prospect of a parliamentary swing to the National Rally has sparked concerns about uncontrolled spending and fiscal imbalances in France.
Market Impact:
The euro has depreciated sharply against the US dollar, reflecting heightened political and economic uncertainty in the Eurozone.
This euro weakness indirectly supports the US dollar, putting further pressure on the yen.
Monetary Policy Divergence
Synopsis: The divergence in monetary policy between the Fed and the BoJ is a key driver of the USD/JPY exchange rate. The Fed's hawkish stance, signalling only one rate cut this year, contrasts with the BoJ's commitment to maintaining its ultra-loose monetary policy.
Key Developments:
The Federal Reserve left interest rates unchanged in June but revised its inflation forecasts upwards, projecting only one rate cut this year.
The Bank of Japan maintained its key short-term interest rate at -0.1% and said it would continue buying Japanese government bonds at the current pace.
Several Fed officials, including Neel Kashkari, have reaffirmed the view that only one rate cut is likely this year.
Market Impact:
The US dollar has strengthened against most major currencies, supported by the Fed's hawkish stance and safe-haven demand amid geopolitical risks.
The Japanese yen has weakened against the US dollar, reflecting the continued divergence in monetary policy between the two central banks.
Conclusion
The direction of the JPY in the coming five weeks will depend on a complex interplay of factors, including the BoJ's policy decisions, economic data releases, and geopolitical developments.
Upward Support:
The JPY could come under upward support if the BoJ signals a more hawkish shift in policy at its July meeting, for example by announcing a concrete plan for reducing bond purchases. A significant improvement in economic data, particularly in inflation and wage growth, could also boost the yen. Additionally, a de-escalation of geopolitical tensions, such as a ceasefire agreement between Israel and Hamas, could reduce safe-haven demand for the US dollar, supporting the yen. The BoJ's July meeting (June 20) will be the pivotal event for this scenario.
Indifference:
The JPY could trade sideways if the BoJ maintains its current policy stance and economic data releases are mixed. Continued political uncertainty in Europe and the ongoing conflict in the Middle East could also contribute to a range-bound USD/JPY. The June 20 CPI data and the June 21 Flash PMIs will be important indicators to watch for this scenario.
Downside Pressure:
The JPY could come under downside pressure if the BoJ maintains its ultra-loose monetary policy and economic data disappoints, particularly if inflation and wage growth remain subdued. A further escalation of geopolitical risks, such as a widening of the conflict in the Middle East, could also boost the US dollar and weigh on the yen. The BoJ's July meeting (June 20) will be crucial in determining whether this scenario materialises.
References
Bank of Japan: https://www.boj.or.jp/en/
Ministry of Finance - Japan: https://www.mof.go.jp/english/
Cabinet Office, Japan: https://www8.cao.go.jp/
Trading Economics: https://tradingeconomics.com/
Bloomberg: https://www.bloomberg.com/
Reuters: https://www.reuters.com/
Financial Times: https://www.ft.com/