JPY Fundamental Analysis: Policy Divergence and Yen Strength
The previous five-months and an outlook for the upcoming five weeks
Thursday, 6 June 2024, Week 23: This report analyses the fundamental factors influencing the Japanese yen (JPY). It examines Japan's fiscal and monetary policies, economic indicators, and geopolitical events that could impact the currency's value in the coming weeks. The report is structured to provide a comprehensive overview of the current market environment and potential future trends, aiming to assist forex traders in making informed decisions.
Fiscal Policy
Japan's fiscal policy remains expansionary, with the government committed to supporting economic growth and achieving its 2% inflation target. The FY2024 budget, released in December 2023, outlined significant spending increases, particularly in areas like childcare, education, and defence. The government also implemented additional economic measures in March and November 2023 to address rising prices and promote wage growth.
Over the past five months, the government has maintained its focus on fiscal stimulus. The "acceleration plan" under the Children's Future Strategy, with a budget of 3.6 trillion yen, is being implemented with urgency, with a significant portion of the funding allocated in the FY2024 budget. The government has also emphasised the importance of "wage increases that overcome price hikes" and has taken steps to improve the treatment of frontline workers in healthcare, welfare, and education.
In the coming five weeks, the government is expected to continue its expansionary fiscal policy. The first expanded child allowance payments are scheduled for December 2024, and the government will likely continue to monitor the impact of its economic measures on wage growth and consumption. The focus on securing financial resources for these initiatives through expenditure reforms and the revision of medical care fees and drug prices will likely remain a key theme.
The government's fiscal policy has had a mixed impact on the economy. While it has supported economic growth and contributed to a rise in inflation, private consumption has remained relatively weak due to persistent price pressures. The government's efforts to promote wage growth have shown some positive results, with the average rate of increase in wages for regular employees reaching its highest level in 33 years in the 2024 spring labour-management wage negotiations. However, many small and medium-sized firms are still struggling to pass on higher personnel expenses to selling prices, which could limit the impact of wage increases on consumption.
The expansionary fiscal policy has also influenced monetary policy. The Bank of Japan (BOJ) has acknowledged the government's efforts to achieve 2% inflation and has indicated its willingness to adjust monetary policy accordingly. However, the BOJ remains cautious about tightening policy prematurely, given the uncertainties surrounding the economic outlook and the potential impact on financial markets.
Economics
The Japanese economy is currently in a state of moderate recovery, but recent data suggests a potential slowdown. The economy contracted by 2.0% on an annualized basis in Q1 2024, driven by weak private consumption, declining business spending, and deteriorating external demand. While the BOJ expects the economy to keep growing at a pace above its potential growth rate, uncertainties remain, particularly regarding the global economic outlook and the impact of the yen's depreciation on households' purchasing power.
Economic Growth: Japan's economic growth has been uneven in recent months. After a downwardly revised stagnation in Q4 2023, the economy contracted by 0.5% qoq in Q1 2024. Trading Economics forecasts a rebound to 0.8% growth by the end of Q2 2024, with long-term projections indicating a trend around 0.4% in 2025. However, the recent contraction highlights the fragility of the recovery and the potential for further downside risks.
Labour: The labour market remains tight, with the unemployment rate holding steady at 2.6% in April 2024. Wage growth has accelerated, reaching 2.1% year-on-year in April, the highest since June 2023. However, nominal wage growth still lags behind core inflation, resulting in negative real wage growth for over two years. Trading Economics forecasts wage growth to moderate to 1.4% by the end of Q2 2024, with long-term projections indicating a trend around 1.6% in 2025. The continued tightness in the labour market and the government's push for wage increases suggest that upward pressure on wages is likely to persist.
Price Changes: Inflation has been moderating in recent months, with the core CPI slowing to 2.2% year-on-year in April 2024, the lowest reading since January. However, core inflation has remained at or above the BOJ's 2% target for 25 consecutive months. Trading Economics forecasts core inflation to ease further to 1.8% by the end of Q2 2024, with long-term projections indicating a trend around 2.0% in 2025. The recent depreciation of the yen and rising commodity prices pose upside risks to inflation, potentially putting pressure on the BOJ to tighten monetary policy.
Trade: Japan's trade deficit widened to JPY 462.50 billion in April 2024, exceeding market expectations. Exports grew by 8.3% year-on-year, but imports expanded at the same pace, driven by higher purchases of mineral fuels. Trading Economics forecasts a trade deficit of JPY 200.00 billion by the end of Q2 2024, with long-term projections indicating a trend around JPY -2,700.00 billion in 2025. The widening trade deficit reflects the impact of the weak yen on import costs and could further contribute to inflationary pressures.
Monetary Policy
The BOJ shifted its monetary policy stance in March 2024, raising interest rates for the first time since 2007 and ending eight years of negative interest rates. The benchmark interest rate currently stands at 0.10%, and Trading Economics forecasts it to remain unchanged at 0.10% in 2025. However, the BOJ has signalled its readiness to adjust monetary policy further, particularly if underlying inflation continues to rise.
The BOJ's April policy meeting summary highlighted upside risks to inflation, including a potential wage-price spiral, further yen depreciation, and rising commodity prices. The central bank indicated that it is monitoring corporate behaviour and consumption trends for signs of sustained economic recovery and price rises that could warrant interest rate hikes.
The BOJ's recent policy shift and its hawkish rhetoric suggest a potential for further monetary policy tightening in the coming months. However, the central bank is likely to remain cautious, given the uncertainties surrounding the global economic outlook and the potential impact of rate hikes on financial markets. The BOJ's decision on whether to reduce its bond purchases will be a key factor to watch in the coming weeks.
Geopolitics and Market Themes
Several geopolitical situations and market themes could influence the JPY in the coming weeks:
US Dollar Strength: The US dollar has been strengthening in recent weeks, driven by strong economic data and uncertainty about the magnitude of Fed rate cuts this year. The ISM Services PMI data for May showed surprisingly strong growth in the services sector, exceeding market expectations. This fueled uncertainty about the magnitude of Fed rate cuts this year, boosting the US dollar and risk appetite for USD longs. This trend could continue to weigh on the JPY, particularly if the interest rate differential between the US and Japan widens.
Bank of Canada Rate Cut: The Bank of Canada (BoC) commenced its rate-cutting cycle on June 4, 2024, decreasing its key interest rate by 25 basis points to 4.75%. This move was widely anticipated and reflected ongoing disinflation and softer economic growth in Canada. The Canadian dollar weakened as a result, reducing risk appetite for CAD longs. This event could indirectly impact the JPY by influencing risk sentiment and the overall direction of the US dollar.
UK General Election: The UK's upcoming general election on July 4, 2024, is creating political uncertainty that could weigh on the British pound. The latest COT report shows that Asset Managers increased their net short positions in the euro, suggesting a bearish outlook for the currency. This uncertainty could spill over into other currencies, including the JPY, particularly if it leads to increased risk aversion in the market.
Gunman Opens Fire on US Embassy in Lebanon: The deteriorating security environment in Lebanon, highlighted by the recent attack on the US embassy, could weigh on investor sentiment towards emerging markets. This could lead to a flight to safety, potentially benefiting the JPY as a safe-haven currency.
Activist Investors Urge London Firms to List Elsewhere: The trend of activist investors urging London firms to list elsewhere reflects concerns about the UK's post-Brexit economic outlook. This could negatively impact the British pound and potentially create a ripple effect on other currencies, including the JPY.
Modi Secures Coalition Support for Third Term in India: The political certainty brought by Modi securing coalition support for a third term in India could boost investor confidence towards the Indian rupee. This development could indirectly impact the JPY by influencing risk sentiment and capital flows in the Asian region.
Conclusion
The JPY is likely to face mixed influences in the coming five weeks. The strengthening US dollar and the potential for further BOJ monetary policy easing could exert downward pressure on the currency. However, the yen's safe-haven status and the potential for risk aversion stemming from geopolitical events and global economic uncertainties could provide upward support.
The key factors to watch will be the BOJ's policy meeting on June 14, 2024, the US jobs report on June 7, 2024, and the US Fed Funds Interest Rate decision on June 12, 2024. These events could provide further clues about the future direction of monetary policy in Japan and the US, significantly impacting the JPY's value.
For forex traders, the current market environment suggests a cautious approach to JPY trading. The potential for volatility remains high, and it is crucial to closely monitor economic data, central bank announcements, and geopolitical developments to identify potential trading opportunities.
References
Bank of Japan: https://www.boj.or.jp/en/
Bank of Canada:
https://www.bankofcanada.ca/
Bank of England:
https://www.bankofengland.co.uk/
Cabinet Office, Japan: https://www.cao.go.jp/index-e.html
Ministry of Finance, Japan: https://www.mof.go.jp/english/
Ministry of Health, Labour and Welfare, Japan: https://www.mhlw.go.jp/english/
Ministry of Internal Affairs & Communications: https://www.soumu.go.jp/english/
Ministry of Economy Trade & Industry (METI): https://www.meti.go.jp/english/
Ministry of Land, Infrastructure, Transport and Tourism, Japan: https://www.mlit.go.jp/en/
Statistics Bureau of Japan: https://www.stat.go.jp/english/
Trading Economics:
https://tradingeconomics.com/
Outlook for Economic Activity and Prices (April 2024): https://www.boj.or.jp/en/mopo/outlook/gor2404b.htm
Statement on Monetary Policy (April 26, 2024): https://www.boj.or.jp/en/announcements/release_2024/k240426a.htm
Summary of Opinions at the Monetary Policy Meeting (May 9, 2024): https://www.boj.or.jp/en/mopo/mpmsche_minu/opinion/opi240426.htm