Kuroda’s Yen Problem Isn’t Going Away No Matter What The Fed Does, Goldman Says

The Bank of Japan’s yen problem isn’t likely to go away no matter what the Fed does.

That’s the message implicit in Goldman’s call to stick with the safe-haven at least through Jackson Hole.

The yen is near its strongest levels since March of 2018 (barring the January flash event) and that’s weighed on Japanese equities. The Topix this week wiped out its YTD gains and the Nikkei has woefully underperformed its developed market benchmark counterparts.

The problem for the BoJ is a familiar one. Having all but exhausted its capacity to ease policy, it’s difficult for the bank to “match” the dovish pivot from the ECB, the Fed, the RBA, RBNZ, and a hodgepodge of EM central banks. At the same time, the yen’s safe-haven status means the currency is prone to appreciating as the geopolitical landscape becomes increasingly fraught. Throw in relative political stability and it’s been tough to keep the yen down.

“We have been recommending bullish Yen positions on the back of elevated trade tensions and the currency’s value as a portfolio hedge”, Goldman wrote Friday, adding that “the uncertain Fed outlook still offers attractive risk-reward for long JPY positions as communication from policymakers is set to be a key driver for markets, and we see plausible scenarios where either outcome (i.e., dovish or hawkish) could be bullish Yen”.

The gist of the bank’s argument is that if the Fed somehow manages to clear the (extremely high) bar for a dovish surprise, rate differentials will move in favor of JPY as US yields fall. If, on the other hand, the Fed fails to impress and Jerome Powell continues to describe additional cuts as part of a “mid-cycle adjustment” (as opposed to the beginning of a long easing cycle), the likely risk-off sentiment that would accompany the FOMC’s perceived recalcitrance would benefit the yen as well.

That’s not the best news for the BoJ, as further currency strength amounts to a disinflationary shock when the bank is nowhere near their notoriously elusive inflation target.

Meanwhile, JGB yields tested the lower-end of the YCC range this week, forcing the bank to cut purchases, underlining the quandary facing Governor Kuroda.

As ever, there is no “right” answer for the BoJ. If the global economy decelerates further and geopolitical tensions boil over into a crisis forcing the Fed and the ECB to resort to drastic measures, Japan may find itself forced to intervene to cap the yen’s gains.

Any intervention would not be received well in Washington at a time when Shinzo Abe needs to stay on Trump’s good side in order to avoid getting dragged further into the US president’s trade war.

Japan’s is not an enviable position.

Read more: Meanwhile, In Japan, Yield Curve Control Fails, Top US Creditor Status Regained