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The announcement of a comprehensive fiscal package on the part of the Japanese government left the JPY exchange rates reasonably unimpressed last week. That is likely to be due to the fact that there is significant doubt as to whether it will have far-reaching effects.
Economic activity in Japan has been hit by the October consumption tax hike as well as the fallout from damaging typhoons. This week, the Cabinet Office reported a sizable fall in October consumer spending, echoed by a decline in auto sales.
However, the main focus in Japan at the start of the week was the updated GDP figures. While the initial estimate of growth in Q3 had implied that the economy expanded by an underwhelming 0.1%Q/Q, we also project a bounce back in H1’20.
Bank of Japan’s monetary policy that is scheduled for the next week, Tankan survey would be significant to watch for further confirmation on business confidence.
While the short-term implied valuations of USDJPY point to further downside bias, but the floor at 108.40/50 remains firm. Expect more downside momentum to build if that level is breached, but note a lack of drivers for the pair to probe significantly lower, unless the Sino-US headlines turn south.
Even though the volume of USD 120bn sounds impressive the major share of it is aimed at reconstruction following recent natural disasters or at cushioning the effect of the recent sales tax hike.
As a result, the stimulating measures are more likely to smoothen growth somewhat rather than stimulating it on a sustainable basis, so that they are unlikely to fuel hopes of rising inflation pressure.
Both the fiscal and monetary policy in Japan seem to have reached the end of the line in this respect, which means that the inflation risks are increasingly pointing downwards. That is in fact a good sign for the yen as low inflation supports a currency’s purchasing power.
We think that Japanese investors continuing to receive proceeds from maturing JGBs will continue to have no option but to invest in foreign securities while shouldering considerable FX risk, because the carry on FX-hedged investment in US treasuries is negative, and we see this as a supportive factor for USDJPY but downside risks remain imminent.
Hence, at spot reference of USDJPY: 108.539 levels, we advocated buying a 2M/2w 109.732/106.50 put spread ahead of monetary policy season that is scheduled for this week (vols 5.55 vs 5.15 choice), the strategy has been functioning as predicted.
Alternatively, shorting USDJPY futures contracts of mid-month tenors have been advocated, on hedging grounds, we now like to uphold the same positions ahead of Fed’s monetary policy as the underlying spot FX likely to target southwards below 106 levels in the medium run. Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: Commerzbank
