Soc Gen Research on Dollar Yen

October 31st, 2014 10:57 am | by John Jansen |

Via Soc Gen Research:

The Bank of Japan (BOJ) surprised almost everyone with this morning’s policy change. Further easing had been widely expected, but not this soon. The BOJ will increase its ‘QQE’ program, targeting an annual increase in the size of the monetary base of ¥80trn, up from the previous ¥60-70trn. Furthermore, the BOJ announced its intention to purchase an additional ¥30trn of JGBs per year (to a total of ¥80trn per year), and to increase the maturity of JGBs it buys to 7-10 years. The Nikkei rallied, the yen fell and JGB yields fell too. Where now?

The BOJ is effectively plugging the hole left by the reduction in the GPIF’s JGB allocation. The GPIF is instead increasing its domestic equity holdings from 12% to 25% of the fund, which will inject ¥16.5trn ($150bn) into the Japanese stock market. The GPIF will also increase holdings of foreign equities and bonds to 40% from 23%, so sending ¥21.5trn ($195bn) overseas. That is negative for the yen.

The short-term implication of the BOJ move is significant yen weakness. Our technical analysts reckon the next stop is around USD/JPY 112/112.80, but 115 and above must be on the radar before year-end. We however have some doubt about what this move means for the longer term outlook.

A broader FX market implication is that the BOJ has helped the dollar trend to reassert itself after an October respite. EUR/USD too is on the cusp of breaking lower as the DXY climbs higher. On a fundamental level, the policy divergence between the Fed, which is ending QE, and the BOJ and the ECB is becoming more acute as the latter two contend with the deflation threat. This divergence will drive the dollar higher into next year.

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