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25 Apr 2013
Forex Flash: There is widespread expectation of lower yen ahead - Societe Generale
FXstreet.com (Barcelona) - Sebastien Galy, Senior FX Strategist at Societe Generale notes that there is widespread expectation of lower yen over the next several quarters given the BOJ's super-QE policy. While he agrees with that view, he sees value is examining how it may actually be wrong.
He looks to Switzerland as a case study and notes that it has pursued one of the most aggressive central bank balance sheet expansion in history in GDP-equivalent terms, and yet not only has the Swiss franc refused to weaken by itself but deflation has remained stubbornly persistent. he adds that Switzerland has had a zero policy rate since August 2011, coupled with an avowed determination to maintain a 1.20 EUR/CHF peg. he writes, “To pursue its super-QE policy, the SNB has swollen its balance sheet to over CHF500 bln. That balance sheet has doubled over the last twenty-one months, an expansion equivalent to almost 40% of Swiss GDP.”
He continues, putting things in context, and writes, “To achieve the equivalent balance sheet expansion in Japan, the BOJ’s balance sheet would have to rise by US$2.2 trillion. The BOJ has announced that its balance sheet would expand to ￥290 trillion by end-2014 from ￥158 trillion in end-2012, which is an expansion of over ￥130 trillion. In GDP-equivalent terms, the BOJ’s announced policy therefore falls well short of what the SNB has achieved in less than two years.” He asks that if the SNB has managed to neither weaken CHF despite direct forex intervention nor induce higher inflation in Switzerland, what makes it so eminently obvious that the BOJ will weaken JPY and raise Japanese inflation through indirect asset purchases of yen assets?
He answers, by noting that it can be argued that its not correct to compare the SNB against the BOJ in GDP-equivalent terms, and it is clear that the BOJ expansion over the next two years will be far larger in absolute terms than the SNB experience thus far. But whatever little we know about the impact of QE on the economy, Galy notes that we know that the relative size of the asset purchase program matters. He states that most observers would agree that a $100bln asset purchase plan will have a much larger impact on a $100 bln GDP economy than on a $10,000bln economy. So the size of the QE program relative to a country's financial market and overall GDP is crucial.
With the Swiss comparison made, he continues to question how he could argue that the BOJ is likely to be more successful than the SNB, at very least in terms of weakening JPY significantly over the next few quarters? He notes that Switzerland is literally surrounded by the Euro area, which has been the epicentre of global financial fears for the last three years. The rolling EA crises have placed significant upside pressure on the Swiss franc as a safe haven, and weak European growth has also placed downside pressure on Swiss inflation. Japan is on the other side of the world, and in a presently more stable (economically at least) region. In short, the specific circumstance of the EA crises makes it difficult to argue that the SNB’s failure thus far will be shared by the BOJ.
Nonetheless, he adds that this very simplistic juxtaposition of the external macroeconomic circumstances faced by Switzerland and Japan also helps to pinpoint the weak link in the consensus weak-yen view, namely the external environment matters greatly to the success or failure of BOJ super-QE policy. Japan's loan-to-deposit ratio is noticeably the lowest among all developed economies, yet domestic private credit growth has been flat for many years. As numerous commentators have noted, there is a credit demand problem in Japan, not a supply one. Given this, he notes that it is not immediately obvious that the BOJ will be able to boost Japanese domestic demand significantly through lower borrowing costs. The BOJ will have to rely on the net exports channel to lift growth through a weaker yen. Furthermore, a declining yen will also help to raise inflation expectations in Japan, again through the external sector.
He finished by commenting, “Hence, the success or failure of BOJ policy will depend crucially on the external sector. If global growth falters, the BOJ is unlikely to succeed as net exports growth will suffer due to weaker external demand. To exacerbate the situation, the safe haven nature of JPY will cause it to rebound even more as it becomes evident that BOJ policy has failed and global growth risks rise.”
He looks to Switzerland as a case study and notes that it has pursued one of the most aggressive central bank balance sheet expansion in history in GDP-equivalent terms, and yet not only has the Swiss franc refused to weaken by itself but deflation has remained stubbornly persistent. he adds that Switzerland has had a zero policy rate since August 2011, coupled with an avowed determination to maintain a 1.20 EUR/CHF peg. he writes, “To pursue its super-QE policy, the SNB has swollen its balance sheet to over CHF500 bln. That balance sheet has doubled over the last twenty-one months, an expansion equivalent to almost 40% of Swiss GDP.”
He continues, putting things in context, and writes, “To achieve the equivalent balance sheet expansion in Japan, the BOJ’s balance sheet would have to rise by US$2.2 trillion. The BOJ has announced that its balance sheet would expand to ￥290 trillion by end-2014 from ￥158 trillion in end-2012, which is an expansion of over ￥130 trillion. In GDP-equivalent terms, the BOJ’s announced policy therefore falls well short of what the SNB has achieved in less than two years.” He asks that if the SNB has managed to neither weaken CHF despite direct forex intervention nor induce higher inflation in Switzerland, what makes it so eminently obvious that the BOJ will weaken JPY and raise Japanese inflation through indirect asset purchases of yen assets?
He answers, by noting that it can be argued that its not correct to compare the SNB against the BOJ in GDP-equivalent terms, and it is clear that the BOJ expansion over the next two years will be far larger in absolute terms than the SNB experience thus far. But whatever little we know about the impact of QE on the economy, Galy notes that we know that the relative size of the asset purchase program matters. He states that most observers would agree that a $100bln asset purchase plan will have a much larger impact on a $100 bln GDP economy than on a $10,000bln economy. So the size of the QE program relative to a country's financial market and overall GDP is crucial.
With the Swiss comparison made, he continues to question how he could argue that the BOJ is likely to be more successful than the SNB, at very least in terms of weakening JPY significantly over the next few quarters? He notes that Switzerland is literally surrounded by the Euro area, which has been the epicentre of global financial fears for the last three years. The rolling EA crises have placed significant upside pressure on the Swiss franc as a safe haven, and weak European growth has also placed downside pressure on Swiss inflation. Japan is on the other side of the world, and in a presently more stable (economically at least) region. In short, the specific circumstance of the EA crises makes it difficult to argue that the SNB’s failure thus far will be shared by the BOJ.
Nonetheless, he adds that this very simplistic juxtaposition of the external macroeconomic circumstances faced by Switzerland and Japan also helps to pinpoint the weak link in the consensus weak-yen view, namely the external environment matters greatly to the success or failure of BOJ super-QE policy. Japan's loan-to-deposit ratio is noticeably the lowest among all developed economies, yet domestic private credit growth has been flat for many years. As numerous commentators have noted, there is a credit demand problem in Japan, not a supply one. Given this, he notes that it is not immediately obvious that the BOJ will be able to boost Japanese domestic demand significantly through lower borrowing costs. The BOJ will have to rely on the net exports channel to lift growth through a weaker yen. Furthermore, a declining yen will also help to raise inflation expectations in Japan, again through the external sector.
He finished by commenting, “Hence, the success or failure of BOJ policy will depend crucially on the external sector. If global growth falters, the BOJ is unlikely to succeed as net exports growth will suffer due to weaker external demand. To exacerbate the situation, the safe haven nature of JPY will cause it to rebound even more as it becomes evident that BOJ policy has failed and global growth risks rise.”