Morgan bullish on yen and Nikkei
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Currencies: USD/JPY -- A Steady Grind Lower
Stephen L Jen (Tokyo)
Following a recent trip to Japan, I reaffirm our team’s view that USD/JPY will continue to trade lower this year. This downtrend in USD/JPY should be gradual, due to the aggressive stance of the Ministry of Finance (MoF). I continue to believe that USD/JPY is a higher quality trade than EUR/USD, as it has not yet overshot, and therefore is not prone to periodic snap-backs. I believe ¥100 will eventually be broken, but most likely later rather than sooner.
A status report on this call: We believe USD/JPY will trade lower this year, for reasons including the following:
Reason 1. The USD is still structurally sick
JPY appreciation has significantly lagged behind EUR appreciation. Not only is the USD index still overvalued, but the out-of-balance nature of the USD correction vis-à-vis EUR and JPY suggests that downward pressures on USD/JPY will linger. Second, while the sentiment on the USD may be too bearish, particularly against the EUR, the general view on USD/JPY is not as strong. Even if the US C/A deficit starts to stabilise, the JPY is in a better position to hold its value than EUR/USD. A recovering USD will likely lead to less MoF intervention, rather than a bounce higher in USD/JPY.
Reason 2. Japan’s economic recovery will continue to impress, both in terms of size and quality
Japan has likely already seen its multi-year bottom in the economy as well as the Nikkei, and we could be approaching a bottom in property prices. All of this is most likely still not fully appreciated by the market. Further, the underlying quality of growth is the best among the G-7 countries, in my view. Not only have exports and capex continued to recover, consumption has begun its incipient recovery. Further, as long as China continues to grow, and as long as Japanese companies believe they can play a complementary role, Japan should benefit directly from net exports and indirectly from capex (as there is the additional need to rebuild capital stock in Japan to satiate the demand of a new market in China).
Reason 3. Private sector reforms continue
Being the third recovery since the bubbles burst 13 years ago, this recovery should be more sustainable. The main reason behind my optimism on the sustainability of this recovery is that both the financial and corporate sectors continue to reform. A private sector being restructured will be more resilient to negative external shocks than otherwise. On banking reform, the total size of NPLs continues to fall. The worst of the financial sector problem is behind us. A further reduction in the risk of a systemic banking crisis should be positive for the Nikkei, and therefore the JPY, all else equal. At the same time, corporate reform is progressing apace.
Reason 4. The MoF can only do so much
The intervention strategy of the MoF is to slow down the pace of the descent in USD/JPY, not to target any specific level, particularly when EUR/JPY stays high. Measured against this objective, the MoF has been very successful in the last 24 months. The MoF is clearly committed to pursuing this aggressive intervention stance. However, it is likely that the MoF will need to work harder this year to maintain the same pace of decline in USD/JPY as that in 2003.
Monetary policy will remain accommodative
Since Governor Fukui took over in March 2003, the BoJ has implemented policies that are accommodative enough to dispel general criticisms of the BoJ and specific pressures from the MoF. This policy stance has, very importantly, helped to divert the market’s attention away from the BoJ toward issues that are much more important, such as banking sector reform. Given that the notional output gap is still large, it is likely that a tightening by the BoJ is not a risk anytime this year.
The external sector will not be harmed by the JPY
I continue to believe that the fears of a strong JPY undermining the recovery in Japan are overblown. The nominal TWI has appreciated only 5.5% in the last two years. Further, Japan’s export price elasticity is extremely low. On our calculations a one percent increase in foreign demand could offset 17% depreciation in the REER of the JPY.
Bottom line
The gradual downtrend in USD/JPY should continue in 2004. Not only are there reasons to expect the USD index to continue to correct, there are JPY-positive factors that will also weigh on USD/JPY. In particular, the underlying growth story of Japan will likely prove to be impressive both in terms of size and quality. The MoF is likely to remain defensive, not offensive, guiding USD/JPY gradually lower at a pace that can be easily absorbed by the private sector. |
