30 Jul 2013
Flash: Falls in the Nikkei to further increase BoJ easing - RBS
FXstreet.com (Barcelona) - In an terrific insightful article, Greg Gibbs, FX Strategist at RBS, dismantles the belief about the positive correlation between the USD/JPY and the Nikkei, noting that despite there is certainly a correlation between the two, it does not fundamentally make sense for a weaker Nikkei to strengthen the JPY.
According to Gibbs, falls in the Nikkei puts pressure on the BoJ to increase its monetary easing: "It suggests that Japanese investors are sensing the economy is slipping into its old deflationary cycle and it is best to hold savings in zero yielding bank deposits" As such, Gibbs believes that "if the BoJ were to witness the continuation of the recent trend it would very likely soon further increase its QE policy."
Ironically, the weaker Nikkei is in fact negative for JPY, Gibbs notes, "and a sustained fall in both the Nikkei and USD/JPY is unlikely as it will soon generate more aggressive BoJ policy easing that will in turn weaken the JPY" the RBS Strategist said.
In the scenario that the Nikkei increases too rapidly, it will potentially be negative for the USD/JPY, "because it suggests that the BoJ’s QE policy is working more through boosting domestic assets rather than to weaken the JPY" Gibbs said, supporting the notion that prospects for inflationary expectations would rise and, as Gibbs notes, "the BoJ QE policy is sufficient and may not need further enhancement to achieve its 2% inflation goal in two years."
On the other hand, if the USD/JPY rises too rapidly, Gibbs suggests "it may have negative feedback on the Nikkei, because it boosts inflation primarily for imported goods that could be viewed as a tax on spending, particularly for domestic-based companies, and may push up Japanese bond yields due to inflation expectations and higher risk premium on JGBs that in turn hurts the real estate sector and bank balance sheets."
Gibbs concludes that "a rapid rise in Nikkei can weaken USD/JPY, and a rapid rise in USD/JPY can weaken the Nikkei; when either occurs, the correlation between the two will appear very high..." Amid this assumption, Gibbs suspects that as things stand, the sharp slide in the Nikkei will soon underpin the USD/JPY.
Gibbs adds: "It would not surprise to see an upturn in the USD/JPY then drag up the Nikkei. The BoJ and the government are not going to sit by and observe a falling Nikkei and falling USD/JPY. Both are clear indications that they need to ramp up policy easing. There should be little doubt that they will do so in aggressive fashion."
Looking at what are the tools Kuroda is watching the most to assess the BoJ policy success, Gibbs notes "a rising Nikkei and weaker JPY as clear markers, and not measuring success through witnessing lower JGB yields." The bottom line, as Gibbs puts it is that after achieving some significant progress on rising inflation expectations in the Tankan and other opinion surveys across business and households, "he will not let the progress made to date be unwound by a strong JPY and weak Nikkei" Gibbs added.
According to Gibbs, falls in the Nikkei puts pressure on the BoJ to increase its monetary easing: "It suggests that Japanese investors are sensing the economy is slipping into its old deflationary cycle and it is best to hold savings in zero yielding bank deposits" As such, Gibbs believes that "if the BoJ were to witness the continuation of the recent trend it would very likely soon further increase its QE policy."
Ironically, the weaker Nikkei is in fact negative for JPY, Gibbs notes, "and a sustained fall in both the Nikkei and USD/JPY is unlikely as it will soon generate more aggressive BoJ policy easing that will in turn weaken the JPY" the RBS Strategist said.
In the scenario that the Nikkei increases too rapidly, it will potentially be negative for the USD/JPY, "because it suggests that the BoJ’s QE policy is working more through boosting domestic assets rather than to weaken the JPY" Gibbs said, supporting the notion that prospects for inflationary expectations would rise and, as Gibbs notes, "the BoJ QE policy is sufficient and may not need further enhancement to achieve its 2% inflation goal in two years."
On the other hand, if the USD/JPY rises too rapidly, Gibbs suggests "it may have negative feedback on the Nikkei, because it boosts inflation primarily for imported goods that could be viewed as a tax on spending, particularly for domestic-based companies, and may push up Japanese bond yields due to inflation expectations and higher risk premium on JGBs that in turn hurts the real estate sector and bank balance sheets."
Gibbs concludes that "a rapid rise in Nikkei can weaken USD/JPY, and a rapid rise in USD/JPY can weaken the Nikkei; when either occurs, the correlation between the two will appear very high..." Amid this assumption, Gibbs suspects that as things stand, the sharp slide in the Nikkei will soon underpin the USD/JPY.
Gibbs adds: "It would not surprise to see an upturn in the USD/JPY then drag up the Nikkei. The BoJ and the government are not going to sit by and observe a falling Nikkei and falling USD/JPY. Both are clear indications that they need to ramp up policy easing. There should be little doubt that they will do so in aggressive fashion."
Looking at what are the tools Kuroda is watching the most to assess the BoJ policy success, Gibbs notes "a rising Nikkei and weaker JPY as clear markers, and not measuring success through witnessing lower JGB yields." The bottom line, as Gibbs puts it is that after achieving some significant progress on rising inflation expectations in the Tankan and other opinion surveys across business and households, "he will not let the progress made to date be unwound by a strong JPY and weak Nikkei" Gibbs added.