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BoJ Is Standing Tall – How High USD/JPY And How Fast?

Market focus this morning has turned to Q1 U.S earning season. Thus far, global equities have started with some mild gains after yesterday’s evening’s open season earning’s surprise beating expectations. It’s somewhat of a steady start compared to the rabid market fallout produced by the new governor at the Bank of Japan last week. The Central Bank from the “Rising Sun” came, saw and delivered its new ‘shock’ therapy “Reflation Policy – Qualitative and Quantitative Program – market participants have been trying to adapt as quickly to the policy’s ever since.

The new BoJ monetary easing is currently exceeding market expectations. Governor Kuroda has stated that he will aggressively implement his “new balance sheet approach” – pledging to double bond-holdings to the equivalent of +1.3% of GDP, unlike the much smaller amount from the Fed, +0.6% of their GDP. This will result in the Yen continuing to trade under pressure amongst the crosses and 10-year JGB’s to fall to new record low-yields. Market analysts have since been wildly picking USD/JPY upside targets expected to be achieved by year-end. They range between 108-114.

Asian FX, particularly the emerging currency’s with the high carry (IDR, INR) and sound macro fundamentals (PHP, MYR, THB) are likely to benefit as investors increase their hunger for higher yield/spreads. Since the beginning of April, the BoJ monetary policy easing has triggered a rate rally across 10-year emerging market rates and selectively supporting high carry currencies like PLN, TRY, BRL, ZAR and MXN.

It was BoJ easing and the Yen carry trade that helped Asian economies to recover strongly from the post FED tightening during the 1990 along with the Asian Crisis. This time around any aggressive Japanese easing could lead to a two-tiered Asian FX Market with the North Asian Block (KRW, TWD and CNY) expected to maintain their underperformance. Despite USD/JPY being a crowded trade, the outright pair is expected to be trading north of 103 within three-months. Strong Yen depreciation is expected to affect Asian FX mainly through the regions FX policy response – intervention, rate cuts and potential capital flow controls.

The Bank of Korea could be the first to respond to Governor Kuroda aggressive policy easing by finally cutting rates by -25bp to +2.50% this Thursday. Their economy is struggling to regain momentum amid declining export competitiveness. Obviously intensifying tensions with North Korea are an added risk, but inflation is a non-issue to the BoK’s easy policy stance – similar to other global inflation concerns, there are none.

The market now expects the dominant Asian currencies to react differently during Governor Kuroda ‘anything at all cost’ reign. The BoJ’s actions supports riskier assets, encouraging renewed risk behavior by global investors ahead of a shift in domestic Japanese investor flow.

The problem with this lemming “train of thought” is that today’s conditions are very different to the Asian crises of old on a number of fronts: