JPY Faces the Risk of More QE in 2016
In 2015, the Japanese Yen was one of the best performing G10 currencies. It held steady versus the U.S. dollar and strengthened sharply against the euro, British pound and commodity currencies, rivaling the greenback in gains versus the CAD, NZD and AUD. While U.S. stocks climbed to fresh record highs in 2015, the outperformance of the Yen and the U.S. dollar, two of the market’s favorite safe haven currencies tell us that 2015 was marked by a year of uncertainty and anxiety. From the Greek crisis to the Paris attacks, there were no shortages of issues for investors to be worried about but geopolitical risks were not the only reasons why investors bought the Yen.
Like the U.S., in 2015 the Japanese economy was on the road to recovery. While there were periods when growth appeared to be lacking – the economy contracted 0.1% in the second quarter, a weak currency and falling energy prices helped the country recovery quickly. With the U.S. dollar expected to strengthen further and oil prices expected to remain weak, the Bank of Japan felt little pressure to increase stimulus. By the end of the year, they made only a technical tweak to their QE program. While it represented a small dose of easing, policymakers were quick to downplay the move causing some analysts to believe that the adjustment diminished the need for another round of QE in 2016.
Whether the Bank of Japan increases stimulus again in the coming year is the biggest question mark for the Japanese Yen. Investors were relieved that Japan avoided recession in the third quarter but the 0.3% rebound in growth highlights the challenges Prime Minister Abe faces in engineering a stronger recovery. While we believe that Japan’s economy continued to recover in Q4, the drop in the Eco Watchers Index, decline in industrial production and retail sales in November along with the muted Tankan survey suggests that growth will be modest at best. We cannot underestimate the impact of a weaker currency and lower energy prices on the economy but as both are expected to bottom in the coming year, the Bank of Japan may have to resort to additional sources of support if the slowdown in China’s economy has a larger impact on Japan.
Meanwhile we don’t expect the BoJ to reach its inflation target in the coming year. The Bank of Japan has no immediate plans to increase its Quantitative Easing program but subdued growth and low inflation could push the central bank to boost stimulus in the first half of the year. If this coincides with additional tightening by the Federal Reserve, USD/JPY could hit new multi-year highs.
However one dose of easing is the most we expect from the BoJ and in 2016, the outlook for the Yen also hinges on the stability of global financial assets. If the Fed’s rate hikes destabilize the market, Chinese growth contracts more than expected or there is an unexpected geopolitical event, the yen could rise sharply as investors unwind yen funded trades.
Swiss Franc – Don’t Rule Out Further Intervention
In January 2015, the Swiss National Bank rocked the markets by abandoning its 1.20 EUR/CHF peg. However investors should not expect another ground breaking move by the SNB in 2016. At the start of the year, the central bank realized that they could no longer defend the peg in the face of potential ECB QE. With EUR/CHF trading below 1.10 for the rest of the year, the strong franc held back the country’s recovery.
In 2016, the prospect of further euro weakness and franc strength means continued headwinds for Switzerland’s economy. Thankfully lower commodity prices, immigration and population growth will support domestic demand. The SNB has made it clear that there are no reasons for interest rates to rise from negative levels and we expect negative rates to remain a reality for the Swiss economy throughout the year. Growth will remain slow, the unemployment rate could rise but with inflation near zero, even a small increase in wages will boost purchasing power significantly. Consumer spending is expected to play a large role in Switzerland’s recovery but for the economy to experience a stronger turnaround we need to see a more meaningful pickup in global economic activity.
In the meantime the SNB will continue to intervene quietly in the Swiss Franc. Having previously set 1.20 as their pain threshold for EUR/CHF, they are obviously not happy with how high the currency traded in 2015 and unfortunately the Franc could appreciate further if the Eurozone falters. SNB Jordan has said that local firms will just have to get use to a strong overvalued franc but he said that if “further tensions in the euro zone itself could also contribute again to abnormally low EUR interest rates, or lead again to CHF appreciating safe-haven purchases….another rate cut by the SNB could certainly not be excluded in 2016.” In other words, there’s a very real chance of additional stimulus from the SNB in the coming year that could drive EUR/CHF to 1.10 and higher.