Goldman Sachs: Japanese Yen Higher Long-Term, More Falls Near-Term

Content provided by eFXnews.

Goldman Sachs exchange rates

Despite the Japanese Yen surging tot its best levels against the US dollar since October 2014 we hear from a leading investment bank that it could strengthen yet further. Robin Brooks at Goldman Sachs writes:

Seen in isolation, last week’s decision by the Bank of Japan (BoJ) to stay on hold is understandable.

After all, the January move into negative rates produced a massive flattening in the JGB yield curve, exceeding anything seen in Apr. 2013 or Oct. 2014.

We therefore have some sympathy for Governor Kuroda who said in the press conference that “we decided to watch the effect of QQE with negative rates this time.”

But this meeting did not happen in isolation.

The market interpreted the January shift to negative rates as validating fears that JGB scarcity limits QQE.

The USD/JPY rate crashed from 120 – its equilibrium level following the QQE augmentation in 2014 – to below 110 in the run-up to last week, pushing inflation break-evens in Japan sharply lower.

Our view going into last week was that the BoJ needed to grab the bull by the horns and dispel the notion that it is running “out of bullets.”

We thought it could do this by shifting the emphasis back to balance sheet expansion by, for example, taking concrete steps to lift housing loans off banks’ balance sheets, something Governor Kuroda floated in a recent speech.

Instead, the BoJ seemed intent on teaching the markets to be “patient,” downgrading the inflation forecast yet again while taking no action.

This is a fateful miscalculation in our view.

Unconventional easing is above all an expectations game, where it is necessary to shock markets again and again, until they have no reason to question a central bank’s commitment to its inflation target.

Preaching “patience” is the opposite, telling markets they expect too much.

There is little doubt in our minds that USD to JPY exchange rate will keep falling in the near term, until Governor Kuroda is forced to respond with overwhelming force.

We therefore hold to our structural view that dollar-yen exchange rate  ultimately will go a lot higher.

But in the short term, it will fall.

Our biggest anxiety is over intervention.

In our opinion, this would throw out the rule book from recent years – that monetary policy is domestically focused – and the market could respond by pushing USD/JPY down to an even greater degree.

Of course, a lot rides on the price action in comings days.

An emergency BoJ meeting may become necessary if Yen appreciation gets out of control.