Yen rise is eroding positive effects of Abe's stimulus policies; will the BoJ step in?

Risk appetite disappeared quickly yesterday evening after Yellen's testimony. The S&P500 future was 1.4% lower than at the European close. US bond yields dropped sharply, with the 2Y yield down 4bp to 69bp and the 10Y yield down 7bp to 1.67% - the lowest since January last year. The US yield curve is the flattest since 2007 - just ahead of the global financial crisis. USD/JPY plunged further, prompting headaches for the BoJ and increasing speculation of intervention. USD/JPY is being hammered lower as we write, almost 250 pips down intraday. 

Bank of Japan governor Haruhiko Kuroda's embrace of negative rates two weeks ago seems to have failed, his currency actually higher since then. Japanese Finance Minister Taro Aso said on Tuesday the yen's recent moves were "rough," issuing a verbal warning to markets against pushing up the currency too much. The country's top currency diplomat Masatsugu Asakawa echoed the minister's comments, saying that he would closely monitor market moves for any excessive exchange-rate volatility.

Verbal warning shots have raised speculation in the markets that Tokyo may intervene in the currency market to weaken the yen. Despite verbal warning shots, the sell-off in USD/JPY continues. The recent currency swings are driven largely by external factors beyond the control of the BoJ. Nevertheless, yen stronger than 110 against the USD would deal a severe blow to Japan's exports.

"When markets are in a state of panic, leaving things unattended could trigger a free fall in the dollar/yen," said Takako Masai, head of Shinsei Bank's markets research division.

Now with banks facing lower profits due to negative rates, manufacturers facing lower profits due to the stronger than expected yen and workers not getting the wage rises expected by now, it seems the positive cycle of expectations is being squeezed. Is Yen's rise eroding positive effects of premier Shinzo Abe's stimulus policies?

With the parliament still debating the state budget for the coming fiscal year beginning in April, we think the government will be wary of deploying additional fiscal stimulus now. For now it looks like Japanese policymakers prefer to hold off on direct intervention and hope that several rounds of verbal warnings would help soothe markets. USD/JPY is currently trading at 111.37 at 1020 GMT after hitting lows of 110.97

Bank of America Merrill Lynch is saying the "lack of BoJ's ammunition may encourage tactical yen buying, raising the risk of Y110 to the dollar on further risk off events".