USDJPY outlook not helped by oil

Will the plunge in the Japanese yen of the last 2 1/2 years help restore Japan’s trade balance into surplus? Japan had long stood out in the industrialised world with its a growing balance of payments trade surplus from the 1980s until early 2011 thanks to a weak a currency and a vast exporting machine. Aggressive advances in the yen during 2007-2011 eroded export’s competitiveness, sending the trade balance into the red four years ago this month. But the currency’s 60% depreciation against the US dollar since early 2012 has increased profitability for exporters and sent the Nikkei-225 into its highest level since April 2000.

Not only has yen weakness helped make exports attractive, but oil’s 50% plunge helped cut imports, making the perfect storm to an economy, whose on-and-off recessions were caused by low consumption, an expensive currency and prolonged deflation.

No doubt that Prime Minister Shinzo Abe’s rise to power in late 2012 was the direct cause to the yen’s decline as his hand-picked governor of the Bank of Japan Kuroda stepped up buying of stocks and bonds with the main goal of lifting inflation towards 2.0%.

First upgrade since July 2014

As oil remains cheap, the road towards a trade surplus later this year cannot be ruled out. Japan’s merchandise trade balance has recovered by 75% since March 2014 as the deficit fell to yen 639 bn. This week the government has upgraded the economic assessment for the first time since July 2014, indicating “Industrial production is picking up…corporate profits show an improvement… signs of improvement can be seen in some areas”, while removing the phrase “weakness can be seen in consumer sentiment recently”.

Oil standing in the way of CPI target

As oil remains cheap and imports decline further, the trade balance could shift into surplus later this year. But what will falling oil do to inflation? Last month, the Bank of Japan said it wouldn’t necessarily take new easing action if CPI fell into negative territory, considering that the reason is due to falling oil prices. As long as the BoJ sees rising wages, economic growth, falling unemployment to be on course to boosting CPI towards its 2.0% price target, then there will be no need to interfere with monetary policy. But CPI – excluding the effects of last year’s sales tax, slowed to 0.5% y/y from last year’s 1.5% peak. Could that be enough for the BoJ to ramp asset purchases in the fiscal year starting next month? Some say the government has taken a more flexible stance towards it’s the 2.0% inflation target and will no longer pursue it now that the currency has weakened substantially and Japanese stocks have rallied 140% since PM Abe’s policies have begun.

That’s it for USDJPY?

Aside from USDJPY nearing its 55-day moving average for the first time in four weeks, we observe that net long contracts in JPY vs USD have broken above their 3-year down channel, which could signify that speculators’ yen bearishness will likely dissipate further. Meanwhile, the chart on the right, highlights the likely inevitability of Japan’s trade balance entering surplus territory after a fruitful three years of yen depreciation. Another impressively positive US jobs report and a possible QE surprise from the BoJ are the key risks to forecasting USDJPY downside, but 117.50 remains a high probability at this point.