JPY: Brexit blocks the exits – Deutsche Bank

Taisuke Tanaka, Strategist at Deutsche Bank, suggests that the US has been groping for an exit to its ultra-loose monetary policy for the recent years but the US economic momentum is weakening.

Key Quotes

“The Fed's sole rate hike in December 2015 might have been overeager. Compounded with the Brexit shock and uncertain outlook for the global economy, risk markets will be continuously weighed and expectations for Fed rate hikes will be receding.

In February, we proposed four contrasting scenarios: 1) observation of an early rate hike on US economic strength, 2) US puts off raising rates, but risk-off remains moderate, 3) risk-off market triggered by non-US factors (such as China), 4) Monetary easing by the Fed due to a US triggered risk-off market.

At present, while the US has not reached the exit, the Brexit has made the scenario 3) the base case, and the scenario 4) is also starting to look like a possibility. Without appearing overly pessimistic, we see some similarities to the failed US exit from the Great Depression in the late 1930s, and the US and global economies may continue stagnating.

If this is the case, we would expect the JPY as a creditor nation currency to become the strongest currency. In 2007-8, Japanese policymakers said that the US financial crisis would only inflict modest damage on the Japanese economy. They wouldn’t accept suggestions that Japan could fall on hard times as yen rise could result in Japanese stock falling further than US ones.

If a vicious cycle of yen appreciation and falling stock prices emerges, macro-economic deterioration would be slow. In the past, without quick policy actions, Japanese economy deteriorated. In recent years, we think it fortunate that the recognition of risk-off as resulting in JPY-bullishness has finally taken hold. Policy makers are thus trying to take pre-emptive measures.

Regardless, under global risk-off conditions, even if the Japan’s policy efforts can provide some support for the domestic economy and asset values, they cannot reverse the course of yen appreciation. Should scenarios 3) or 4) play out, Japan's exit from a deflationary mindset will likely be prolonged.

The USD/JPY rose from 75.35 on 31 October 2011 to 125.86 on 5 June 2015 during the “Abe market”, so 100.60 represents a 50% dip. Although the rate temporarily fell below this level with the Brexit shock, we had thought that if it could hold above 100 then some remnants of the positive effects from the yen depreciation and rising stocks seen under Abenomics could still be alive.

However, Brexit repercussions could continue over the medium to long-term. If the US economic cycle passes its peak, then we do not believe the USD/JPY will be able to maintain the current ¥1-2 of leeway above 100, and the Abe market would come to an effective end. The next significant Fibonacci level is a 61.8% dip to 94.64.”