So one of the things we spent quite a bit of time on Thursday was what the ongoing slide in the dollar, supercharged this week by Steve Mnuchin’s tacit reiteration of Trump’s adversarial trade stance, means for the ECB and the BoJ.
Mario Draghi’s not-at-all veiled reference to Mnuchin in Thursday’s post-meeting presser was a clear indication that the ECB is acutely aware that a rapidly depreciated dollar has the very real potential to derail the effort to call an end to APP in September and that, in turn, would effectively mean pushing a rate hike back (the ECB won’t hike until QE has officially ended).
The same goes for the BoJ, which earlier this month inadvertently triggered a sharp move in USDJPY when they cut purchases of 10-25Y JGBs. Two weeks later, at the January meeting, the bank tweaked its inflation language, leading to further yen strength before Kuroda tried to calm everyone down with a dovish presser (largely to no avail).
The perception that the ECB and the BoJ are set to lean ever more hawkish weighed heavily on the dollar all month. Thus, Mnuchin’s rhetoric was just fuel on the fire and to the extent Draghi and Kuroda were already wary about the outsized reaction in the euro and the yen to hawkish December minutes and the paring of JGB purchases, respectively, they’re even more worried now.
Well on Friday, Kuroda told a forum in Davos that he’s seeing “indications of rising wages and prices”. He also underscored the BoJ’s religious commitment to the ever elusive 2% inflation target, but it was the upbeat tone that traders latched onto (i.e. everyone took the positive outlook to be yet another sign that the BoJ will begin to try and normalize policy). Needless to say, that catalyzed an immediate dip in USDJPY which, for the reasons cited above, was vulnerable:
As a reminder, that reaction is precisely why everyone has been saying since January 9 (when the JGB news hit) that Kuroda faces a daunting communications challenge. The slightest hint that he’s leaning in the direction of rolling back stimulus (or even just that he’s gaining confidence on the inflation front) risks an outsized reaction in the yen thanks in no small part to the backdrop of persistent dollar weakness. This is what Albert Edwards warned about three weeks ago.
Well this provides a perfect opportunity to excerpt a few passages from a new note by Deutsche Bank’s Masao Muraki.
“The speculation of tapering the monetary policy [in Japan] is premised on the forecast of yen depreciation resulting from the Fed and ECB’s tapering, however, if the yen appreciates, the BoJ would have little room to taper its monetary easing,” Muraki writes, before noting Draghi’s implicit criticism of Mnuchin in Thursday’s ECB presser.
“Japan may start to talk down its own currency if jawboning interventions and retaliations become commonplace again like they were in 2016 through 1H 2017,” he continues.
Here’s a history of currency moves annotated with notable events and Japanese monetary policy changes:
One obvious question here is what further yen appreciation would mean for the ongoing rally in Japanese equities. Well, here’s what Deutsche has to say on that:
Our model, which incorporates US stocks (S&P500) and foreign exchange rates ($/¥), has remained accurate in explaining the recent moves in Japanese stocks (TOPIX) (Figures 16-17). If the yen were to appreciate ¥10 against the dollar, to offset the impact on Japanese stocks, US stocks would have to rise 5%.
You can take all of that for what it’s worth (or isn’t worth), but the general takeaway here is that everyone is suddenly trying to project what’s next now that Mnuchin has seemingly kicked off a “hot” currency war.
That’s readily reflected in the title of Muraki’s note, which is “Re-start of currency wars? Impact on monetary policy and stocks.”