BoJ’s worry could pose a risk to yen long positions

The Japanese yen is undoubtedly the strongest performing currency on a year to date basis. Gaining over 8.50% since the start of this year, the yen’s rapid and strong appreciation has left many at the Bank of Japan concerned. For an export-oriented economy, Japan’s higher exchange rate could mean exporters are taking a hit. The Nikkei225 index has so far been one of the worst performing indexes this year, losing 17.43% on a year to date basis.

The Bank of Japan has made somewhat futile attempts to stem the currency’s appreciation but with little success to show. In late January this year, the BoJ tried to use the ‘shock and awe’ by cutting interest rates into the negative to -0.10%. While it did help to weaken the yen, the efforts were soon wasted as investors continued to flock to the safe haven currency, amid a global rout in the stock markets.

With the BoJ’s QQE already sitting at 80 trillion yen, market participants believe that the BoJ is perhaps putting itself into a corner with nothing to show for. Even a further expansion to the QQE is unlikely to deter the markets. In this week alone, the yen is up over 1.11% to the dollar, and it was not surprising to hear echoing concerns in veiled attempts to talk down the currency.

Earlier on Tuesday, BoJ’s ex-deputy Governor Kzumasa Iwata was quoted as saying that the BoJ will have to cut rates even further, to as much as -1.0% from the current -0.10% as the central bank reaches the limit of it ultra massive QQE come mid next year. He said that failure to cut rates to -0.70% or even to -1.0% would risk the economy returning to deflation.

His comments contrast that of BoJ’s Governor Kuroda, who ruled out further negative rate cuts for the time being facing a backlash in the country.

This week also saw comments from Japan’s Chief Cabinet Secretary Yoshihide Suga, who warned currency speculators against excessive currency movements saying that the government would coordinate with international partners to take the appropriate action as necessary. In a knee-jerk reaction, USDJPY bounced off but yet again the gains were limited.

Later in the day, Japanese Premier Shinzo Abe said in an interview to WSJ that “whatever the circumstances, we must definitely avoid competitive devaluation” which could be seen as Japan trying to toe the line on verbally intervening in the markets or sending a message to other central banks, more importantly the Federal Reserve which has taken a dovish stance on rate hikes, leaving most of the currencies to appreciate strongly.

USDJPY – Long term technical outlook

USDJPY is currently trading at 110.3, a level which is seen as the line in the sand for the BoJ. However, we expect further downside to continue. In fact in our January’s analysis for USDJPY we mentioned downside risks towards 102 – 103 levels with a revised outlook to 104.5, published here.

While the BoJ might not like the current levels in USDJPY, it is likely to see a period of more pain as the yen continues to surge higher. While of course the technical patterns could change based on the outcome of the fundamentals, we expect the current declines to stall near the 104.5 levels before a new bullish trend starts to play out. The monthly (March) candlestick closed in a doji which comes off February’s strong bearish declines, which could indicate a potential retracement on the horizon unless prices continue to post a steady decline lower.

In the meantime, USDJPY could see short-term risks of a rally back to the 166.5 – 117.0 levels which will likely offer investors a relatively decent level to add to the short side.