Days before last week's BOJ "stunner" in which the Japanese central bank ended up doing precisely nothing and smashing market expectations of further "bazooka" easing, we presented Goldman's expectations why the Yen is set to "collapse" in the next 12 months, with Goldman's FX strategist explaining why he believes the USDJPY will surge to 130 in the coming year. For those who missed it, the forecast was based on the assumption of much more aggressive easing including even more balance sheet expansion, something which clearly did not pan out (as we also warned) and the only "crushing" that took place was to the P&L of any Goldman clients who listened to the bank.
Then moments ago Robin Brooks came out with his much anticipated mea culpa in which he admits he misjudged the BOJ which has reverted to a "patient" narrative, saying "this is a fateful miscalculation in our view" but admitting that while "we hold to our structural view that $/JPY ultimately will go a lot higher... in the short term, it will fall."
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. $/JPY 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 $/JPY 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 $/JPY ultimately will go a lot higher. But in the short term, it will fall.
Goldman then adds what Kuroda should be doing:
There remains the question what the BoJ can and should do. As we argued in the run-up to last week’s meeting, the BoJ needs to shift the emphasis of easing back to balance sheet expansion and QQE. While we do not believe that fears over JGB scarcity are well founded – there is plenty of scope for the BoJ to lift JGBs from non-banks (Exhibit 5) where the allocation to JGBs is high compared to government bond allocations elsewhere (Exhibit 6) – we think the BoJ needs to signal that it is not afraid to expand QQE beyond JGBs if needed by, for example, taking concrete steps to lift housing loans off banks’ balance sheets. We think such a step would cause $/JPY to rapidly move back above 120, as market fears over limits to QQE abate. Unfortunately, Governor Kuroda last week only floated additional rate cuts as the possible next easing step, something the market at this point disdains and, rightly, sees as incremental easing.
Until Governor Kuroda is willing to grab the bulls by the horns and confront market fears over the BoJ’s balance sheet, the path of least resistance for $/JPY is down. 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 $/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.
It will be hardly encouraging for Goldman clients to hear that only an emergency central bank meeting will be the catalyst that delivers the long awaited move higher in the USDJPY, even as Goldman actively fails to note that according to the recent G-20 statements and last Friday's Treasury warning an aggressive devaluation by the BOJ will henceforth be actively frowned upon.
But more importantly, Goldman's admission that "the path of least resistance for $/JPY is down" may be just the "all clear" signal the market has been waiting for to go long the USDJPY, and judging by this morning's reaction which has seen the currency pair spike higher, it is doing just that.