Did the BoJ Kill USD/JPY Rally?

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There were a few pieces of economic data released this morning, but the big story today is the sell-off in USD/JPY. Last night, the Bank of Japan increased their inflation target to 2% and announced an open ended asset purchase program which was exactly what the market had hoped for and yet rather than rising to a fresh 2.5 year high, USD/JPY collapsed, falling to a low of 88.35. There was quite a bit of volatility around the rate decision. The hour before the BoJ announcement, profit taking drove USD/JPY from 90 to 89 and immediately after the decision, the currency pair rebounded towards 90 but then collapsed into the European open. Right now its headed back towards its lows courtesy of the decline in U.S. existing home sales.

Sales of previously owned homes fell 1% in the month of December as fewer homeowners listed their property towards the end of the year. While the number of homes sold dropped to 4.94 million, this was still the second highest number of homes sold since November 2009. The data shows that low interest rates continue to provide underlying support for the housing market especially considering that the median price of a home sold also increased 11.5% yoy last month.

On the surface, the Bank of Japan made some dramatic changes to monetary policy but the details of their decision was far less aggressive. Here are 3 reasons why the BoJ killed the USD/JPY rally – for now.

1. Decision to Adopt Higher Inflation Target was Not Unanimous – The Bank of Japan shifted to a 2% inflation target but the decision was not unanimous. Takehiro Sato and Takahide Kiuchi voted against the new target, saying that it was too high and that a growth strategy was needed first. Based on the central bank’s CPI revisions, the members who voted for the target seemed to have very little confidence in achieving their goal. The BoJ upgraded their 2014 core CPI forecast by a mere 0.1% to 0.9% which means that they believe their “open-ended APP program” will only boost inflation by 0.1% next year. So realistically, 2% inflation probably won’t be achieved until 2015 or 2016 at the earliest. In fact instead of providing a specific year, the BoJ even said the deadline for achieving their target is “the earliest possible time,” which confirms our belief that they have no confidence in boosting inflation to 2%.

2. No Changes in Asset Purchases in 2013 – Yet the main reason why the BoJ decision was such a huge let down was because open-ended asset purchases won’t start until 2014, leading investors to wonder what type of support they will provide to Japan’s economy between now and then. Japan won’t be getting any additional stimulus this year as the central bank keeps current asset purchases intact for 2013 and that’s bad news for Japan and USD/JPY.

3. Buy the Rumor, Sell the News – After enjoying a very nice rally over the past 2 months, the lack of an immediate shift to an open ended APP program triggered profit taking in USD/JPY. Expectations were extremely high going into the BoJ meeting and the central bank needed to deliver more than the market had discounted. Unfortunately when sentiment is so skewed, the potential of disappointment is also very high and by unde rdelivering, the BoJ killed the rally in USD/JPY for now.

If USD/JPY reversed after the BoJ adopted a higher inflation target and increased asset purchases immediately, we would argue for buying on dips. However, since they don’t plan to increase support until 2014, the Japanese economy will have to rely on fiscal stimulus alone, which isn’t enough.

While we still believe that the USD/JPY will head higher in the coming year, further gains now hinge upon more aggressive measures by BoJ Governor Shirakawa’s successor who will take over in April. Losses should be limited but we wouldn’t surprised if USD/JPY dropped to support at 86.40.

Kathy Lien
Managing Director

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