- Abe's victory eliminates bullish catalyst for the yen, with BoJ set to continue ultra loose policies
- Crude oil strength should result in rising inflation in Q4 2017, with US dollar likely to rally further
- Despite skepticism, Trump is now delivering wins and tax reforms are looking more likely
Following Abe’s landslide win in the recent Japanese elections, there are few catalysts that can lead to meaningful weakness for USD/JPY. Instead, we argue that it’s time to get bullish on USD/JPY thanks to rising interest rate differentials, higher future inflation, and the increasing likelihood of Trump getting tax reforms through Congress. All three factors bode well for USD/JPY as the dollar to yen exchange rate approaches 115 and beyond. Q4 has historically been a strong quarter for the currency pair, and Q4 2017 looks to repeat this phenomenon.
Abenomics continues, 'on hold' BoJ creates weaker yen
Despite Abe’s low approval ratings amongst the Japanese electorate, his landslide victory in the national elections means that Abenomics is set to continue. Thus Japan is likely to continue on its current path of monetary easing with or without Kuroda at the helm of the Bank of Japan.
Unlike its developed market peers, Japan continues to experience relatively weaker economic growth and low inflation. As such, the BoJ is in no rush to consider reducing the scope of asset buying or moving towards positive interest rates. As fellow central banks ease off from ‘extraordinary’ monetary policies, with the ECB halving the size of its asset buying program and the Fed likely to raise rates in December, the divergence between Japan and its peers is widening. Thus the case for a weaker yen, as predicted in textbook economics, will be supported by larger interest rate differentials.
Relative growth rates comparing Japan to select developed economics is illustrated below. Since Q1 2013, Japanese GDP growth has averaged 1.2% - the lowest amongst its peers shown below.
Japanese growth continues to underperform relative to peers
Dollar impact: strength in crude oil means higher Q4 inflation
In an earlier commentary assessing crude oil market dynamics, we argued that supply is likely to remain subdued in 2017, helping the commodity to keep rallying. Despite concerns regarding market imbalances, Chinese demand remains steady while US supply has been relatively slow at coming back online this year. As such, the upswing in crude that began in Q1 2016 is likely to remain supported.
Given the significance of crude oil in the overall economy, crude prices are a great front-runner for inflation. This is because crude oil is a core input for many products and services, and rising crude prices thus tend to translate into higher prices overall. Eventually, higher crude oil prices are reflected in higher rates of inflation in rate-of-change terms. This increase in inflation will understandably have an impact on us dollar to yen exchanges, in addition to other currency pairs.
Given rising crude prices since the summer of this year, we have argued that this is bullish for the US dollar. Rising crude prices have yet to be reflected in CPI data, but may show up in Q4 2017 or early next year. The trajectory of inflation, which is currently falling in rate-of-change terms, is thus more likely to rise in the future. Once this is reflected in CPI figures, expect the dollar to rise sharply.
US politics impacting USD/JPY exchange: Trump's victory
Lastly, the dollar is likely to strengthen on rising hopes for Trump’s economic agenda. Earlier today, we commented on the importance of the recent House budget resolution vote. Getting the budget resolution through both the Senate and the House is Trump’s biggest legislative victory so far, and is a good sign for the broader tax reform bill. While markets have been skeptical of the White House’s ability to get things done, this is changing. In late September, we argued that markets will ultimately learn to appreciate Trump despite his unconventional ways.
Today’s strength in the dollar suggests that markets are learning to like the president’s way of getting things done. This bodes well for stronger dollar to yen exchanges for the foreseeable future.
Given the White House’s broader agenda which includes healthcare reforms, fiscal spending and a larger military budget, getting tax reforms through Congress should result in a much stronger dollar. All of Trump’s initiatives are positive for growth and inflation, and the dollar should rise on increasing expectations as a result.
Final word on USD to Yen
All in all, USD to JPY is set to strengthen for the rest of the year thanks to the BoJ sticking to monetary easing, thereby minimizing the overall strength of the yen. The US dollar is likely to rally on higher inflation and Trump's economic agenda.