Wednesday, October 28, 2020

BoJ will probably stay dovish while keeping policy on hold, but yen will likely strengthen on the back of a volatile election week

  • Dollar
  • Yen
  • Bank of Japan


Analysts’ Pick: BoJ will probably stay dovish while keeping policy on hold, but yen will likely strengthen on the back of a volatile election week

  • USD/JPY may continue to face downward pressure as the currency pair is more likely to be used as a potential hedge against volatility during the elections
  • It may however open up and opportunity for some longer-term short positioning on the yen as the BoJ in our view is more likely to ease in future policy meetings
  • Stronger headwinds opposing the Japanese economy will probably only play out over the longer-term as the current economic environment is unlikely to give the BoJ strong urgency for monetary easing

The Bank of Japan's (BoJ) monetary policy meeting will end tomorrow, but don't expect much surprises from the central bank. We expect the BoJ to keep monetary policy on hold as it faces little economic pressure for urgent easing. This is due to the relatively strong economic data released since the bank's last meeting in September as well as easing daily Covid-19 in the country. That said, we view this to be more of a conservation of the bank's monetary policy tools for 2021 as a result of the high levels of uncertainty surrounding the Covid-19 pandemic and subsequently the potential recovery for the Japanese economy.

Covid-19 cases in Japan remains well below peak levels despite showing some acceleration over the past two weeks


Most economic indicators have recovered back closer to pre-pandemic levels. The heavily-relied on Japanese exports has recovered 44.66% (non-seasonally adjusted merchandise trade exports) since reaching a 10-year low back in May. Exports may however remain closer to current levels as we see growth flatlining following the easing of pent-up demand for goods and services across the world. Jibun Bank's Composite and Manufacturing PMI has also continued to improve since the BoJ's September meeting, which is likely to be welcomed by policy maker as some sign of progress towards an economic recovery in Japan. Finally, Japan's Covid-19 cases has mostly eased since experiencing a second wave during the July-August period. While numbers appear to be inching higher, the likelihood of a full-on lockdown by the Japanese government remains low at this point. With the above, we do not expect urgency from BoJ policymakers in easing monetary policy at tomorrow's decision, especially with its high ceiling for asset purchases (corporate bond holdings are still almost half of its upper limits; commercial paper holdings have been unwound since mid-September to 4.5 trillion yen and is less than half of the upper limit; ETF purchases remain at only 55% of its ceiling as of end-September; REIT purchases remain at 54% of its ceiling as of end-September).

Improvements in exports and PMI continues to show economic activity in Japan recovering


That said, the Japanese economy faces stronger headwinds moving into 2021. We are already starting to see the central bank shift its focus towards corporate debt and away from short-term liquidity, likely in a bid to mitigate some credit risk that is likely to materialise in the medium-to-long-term. Bankruptcies will probably play a strong part in the first half of 2021, which the BoJ already likely expects. Other key indicators such as unemployment and inflation show slow progress as well, and will probably remain at elevated (or in the case of inflation, low) levels for a prolonged period of time. Core inflation in particular, dipped back below 0 and continued to remain in deflationary territory during September, but may be attributed to government subsidies to help alleviate the pressure off of the travel and leisure industries. We may continue to see deflationary figures moving forward due to the impact of the sales tax hike in October 2019, which should cause a shift in YoY percentage differences. The BoJ, while likely to use the previous reasons for the current deflationary environment, will probably continue to keep a closer watch on inflation in the coming months as it is more likely that consumer demand will flatten out below pre-pandemic levels. Continued growth in unemployment in the country is also likely to put pressure on the BoJ in the longer-term as well.

Unemployment and inflation will likely put longer-term pressure on the BoJ for further stimulus


Today's meeting is likely to result in a hold with an overall dovish tone, while opening up possible easing in upcoming meetings to possible additional monetary stimulus. The reason for the dovish tone is for the BoJ to give little reason for the yen's appreciation, especially with the current political environment favouring the currency as a safe haven asset. While short-term economic activity gives the BoJ some leeway, the weakening outlook for the Japanese economy is likely to pressure the central bank into easing further, likely with specific targeting towards corporate lending in our view to help finance medium-term liquidity. This would mean that the yen could have some potential downside in the short-term and possibly in the longer-term. However, with the upcoming US presidential elections, there may likely be opposing upward pressure on the yen as investors hedge against potential surprises in the election outcome. In our view, this opens up additional downside potential for the Japanese yen in the medium-to-long-term as the political situation in the US regains certainty. Consequently USD/JPY may have some additional downside potential towards 103.73's level, but we don't expect a strong selloff in the currency pair to hit below 102's level without a catalyst, namely a possible non-peaceful transfer of power in the US. In the longer-term, we expect the currency pair to start to recover on the back of a weaker yen, although this strategy may better benefit the euro-yen cross due to the dollar's likelihood of weakening post-elections as well.

Technical Analysis:


The dollar yen remains in an overall downtrend over the past few months thanks to prospects for a weaker dollar as well as a stronger yen on the back of added volatility since September. While we expect a rebound based on a weaker yen on the back of additional easing from the BoJ and alleviation of uncertainty post-US presidential elections, there still appears to be room for USD/JPY to continue on a downward trajectory in the short-to-medium-term. In the short-term however, there may be some slight rebound in the currency pair if RSI sinks deeper into oversold levels, closer towards 25.00. MACD also confirms that the currency pair is displaying bearish signals. Expect more volatility this week and next, as more investors hedge using this currency pair to avoid some volatility in the equity markets.

Support: 103.73 / 103.00 / 102.03

Resistance: 105.07 / 105.72 / 106.15

USD/JPY Chart (H4)