In just over a week we have seen the dollar fall approximately 600 pips against the Japanese Yen to its lowest level since October 2014. Alarms should be ringing at the Ministry of Finance and Bank of Japan because the 5% appreciation spells big trouble for Japan’s businesses and economy. However, everything that we have heard from the Japanese government so far suggests that they are not ready to intervene in the foreign exchange market to lower the value of their currency. The last time the Bank of Japan intervened in the currency was in 2011 after the earthquake and tsunami (and that was coordinated). Since then we have seen USDJPY fall as low as 76 and average around 102.25 over the past 4 years. So Japan has and can tolerate a stronger yen although they have less flexibility with monetary and fiscal policy because extensive action has already been taken through these years. While we believe the Japanese government should intervene given the weakness of the currency, there are a number of reasons why they won’t – they could be waiting for the G7 meeting, they could be waiting for fresh fiscal stimulus, or they could be waiting for the markets to capitulate first. They could also be looking into monetary stimulus rather than direct intervention to avoid being singled out for competitive devaluation of their currency at the G7 meeting in late May – because the host never wants to be embarrassed.
On a fundamental basis, it is becoming clear that the BoJ could allow USD/JPY to fall to 105 and maybe even 100 before taking action. In early February they let USD/JPY fall close to 1100 pips before there was also indication of intervention. While it has not been confirmed on February 11th, after dropping to a low of 110.98, USD/JPY jumped 200 pips in 20 minutes – price action that is indicative of intervention. USD/JPY still has 500 pips to go before this capitulation point, which would put the pair right between the 100 and 105 level. However we would be surprised if the BoJ let USD/JPY fall 1000 pips from its March 29th high of 113.80 without checking rates near 105.
On a technical basis, there’s no support in USD/JPY until 106.63, the 38.2% Fibonacci retracement of the 2011 to 2015 rally. We expect USD/JPY to test and bounce off this level. However if the Fib is broken then it should be smooth sailing down to 105.85, the 200-month SMA. So while the Bank of Japan could allow USD/JPY to drop 1000 pips from its recent high, there are enough key technical and psychological support levels between now and then to make it a choppy and not one-way move.
Risk aversion was one of the main reasons why USD/JPY fell sharply today and other pairs came under selling pressure as well. Next to the Yen pairs, AUD/USD experienced the greatest weakness, ignoring the uptick in gold. A deeper contraction in construction sector activity and AUD strength is raising concerns about further RBA easing. Earlier this week the Reserve Bank said A$ appreciation could complicate economic adjustment and while RBA’s Kent didn’t talk monetary policy last night, he said it is too early to gauge how well the labor market is doing. On a fundamental and technical basis, there are signs of a stop in AUD/USD. NZD fell in sympathy with the Australian dollar but RBNZ Deputy Governor Bascand’s comments also weighed on the currency. He described wage pressure as weaker than expected and said monetary policy should remain accommodative.
Meanwhile the euro held up exceedingly well after ECB President Draghi avoided any comment about the currency. He simply said recent measures will help further price stability and indicated that there’s no shortage of tools available to the ECB. Policymaker Smet shared the same view in a separate speech later where he said the central bank has tools to respond to shocks if needed including lower rates and expansion of unconventional policy but they prefer to wait to see the impact of the March package. The ECB minutes were also relatively benign although slightly more dovish as some members considered a sharper rate cut but others opposed because they considered a larger move as reaching lower bound. While the main takeaway from the ECB is that policy could be reduced further the lack of urgency and/or direct mention of the currency was enough to keep the euro bid.
The Canadian dollar will be in play tomorrow with labor market numbers scheduled for release. Given the rise in the employment component of IVEY PMI and last month’s soft report, a rebound is anticipated. So while oil resumed its downtrend and we believe that CAD should be trading lower, there’s scope for a pullback in the currency that could give investors the opportunity to buy at a lower level.
Sterling remained weak and on track to make another run for 1.4000 versus the U.S. dollar. U.K. industrial production and trade numbers are scheduled for release tomorrow but risk appetite could have a more significant impact on the pair.