Outlook for 2023: Wary of a resumption of yen depreciation after the spring, the factor of the fluctuation up and down is Japan-US monetary policy = Daisuke Karakama | Reuters

TOKYO (31st) – The dollar/yen exchange rate in 2022 will be the biggest yen depreciation since the Plaza Agreement of 1985. It will undoubtedly be a year in the history of the FX market.

The dollar/yen exchange rate in 2022 will be the largest yen depreciation since the Plaza Agreement of 1985. Mr. Karakama for 2023. June 2017 (2022 REUTERS/Thomas White)

Exactly one year ago (December 2021), I wrote a Reuters column regarding the outlook for the foreign exchange market in 2022, saying, “Unfortunately, at the time of writing this article, I feel that the mood will be ‘avoid Japan ‘ continues..”

The nominal effective exchange rate (NEER) of the Yen has fallen by a maximum of 15.5% since the beginning of the year (at the end of October), and has fallen by almost 10% at the time of writing (as of the middle of this article) . December), after the Yen bounced back to its strength. It is often said that a weak yen is the flip side of a strong dollar, but this is not the point.

The dollar’s NEER started to rise in earnest after the end of April, but the yen’s NEER plunged in early March (the yen’s NEER fell by 5% in March alone). The depreciation of the yen this time was triggered by negative evaluations of the Japanese economy, which itself could be described as a movement to avoid Japan.

Even looking at the subsequent increase in the NEER, it is clear that it has deviated from other currency movements, and it is unreasonable to interpret the entire depreciation of the yen solely on the strength of the dollar (as a factor, the rate differential rising interest between Japan and the US) I think

What kind of image should we have regarding the dollar/yen exchange rate in 2023 after such a historic year? At the moment, there seems to be a strong tendency to think that the year will be a year of strong yen. Certainly, as long as the yen is traded at a floating exchange rate, there is no great sense of inconsistency in the fact that the yen will appreciate in the year following such a devaluation. However, will it be possible to get to the end of 2023 with just a strong yen?

A simple picture of the future is that rate hikes by the US Federal Reserve Board (FRB) and the prevention of rate hikes are the main themes for the period between January and March, while the US interest rate falls and the Yen appreciate in response. to the depreciation of the dollar, likely to be encouraged. This appears to be a problem of awareness shared by many market participants.

At this time, it is likely that the price range for 2022 will drop to less than 130 yen. The foreign exchange market is always overshooting, so there is a possibility that it will fall into the 125-130 yen zone.

However, a return to around 112-113 yen in early 2022 seems fairly difficult. As mentioned above, the depreciation of the yen this year is considered to be the result not only of the appreciation of the dollar but also of the depreciation of the Yen. Even if there is room for the Fed to move the overall strength of the dollar into a dovish shift (pivot), the overall weakness of the Yen, which has been distorted by the largest trade deficit in history, will not be resolved.

Intuitively, it is hard to imagine that the currency of the only country with negative interest rates will continue to be bought in a world with huge trade deficits. Of course, the trade deficit in 2023 will be smaller than in 2022, but the deficit itself will be difficult to eliminate. In addition, considering Leeds & Lags of foreign exchange contracts, I believe that the deficit in 2022 will be effective in 2023 as well.

What will happen after April-June? There is also a view that the Yen will continue to appreciate in financial markets, returning to the level at the beginning of 2022. Will that really happen?

Given the above interest rate and the supply-demand environment in Japan, there are naturally doubts about the sustainability of yen appreciation, but that is not the only reason. If the consensus develops, it would confirm the Fed’s suspension of rate hikes from the April-June quarter onwards. However, I believe it won’t be until late 2023 when a rate cut as the “next step” actually falls within the range of market expectations.

However, there are various theories on this point. Since there are also those who expect an interest rate cut, if the outlook for the dollar/yen exchange rate varies, how likely are they to expect an interest rate cut?

If we take the view that there will be no interest rate cuts in 2023, the financial markets will have a moderate period of time when we do not have to expect major policy changes from the Fed for now. Symbolically, lower volatility could lead to higher stock prices.

Since the BOJ will not cut interest rates, it is very likely that domestic and foreign interest rate spreads will remain at a correspondingly high level from Japan’s perspective. The same should happen not only against the dollar, but also against the yen’s cross currencies.

“Enough interest rate differentials” and “low volatility” are the two main conditions for holding trades. During 2010, the interest rate differential between Japan and the United States attracted attention as a factor for yen selling. In a situation where only the Yen has a negative interest rate, it is very difficult to follow a path where the currencies of countries with a large trade deficit continue to rise, and it is difficult to explain.

Conversely, it is hard to intuitively imagine a situation where there is sufficient interest rate differential and low volatility, and when stock prices are high and risk sentiment is strong, the currency of a country with a trade deficit will only appreciate .

The above is the main scenario, but the risks spread up and down. I would like to mention one of the main ones.

Firstly, in terms of the risk of the Yen unexpectedly depreciating too much, is it possible that the Fed will continue to raise interest rates? Even if it is clear that the US inflation rate has peaked, is it true that many market participants assume that interest rate hikes will stop during the January-March quarter?

The personal consumption expenditure (PCE) deflator is about 4.7% year over year in the trimmed average index estimated by the Dallas Fed, more than 5% on a core basis, and more than 6% on an aggregate basis. Will it conclude that it has stably converged to a trajectory of around 2% during the first three months of the year?

The rate of inflation is likely to slow easily from 10% to 5% on the back of easing supply constraints and falling energy prices You have to have an idea of ​​where you are going. There is some ambiguity here.

Currently, the consensus for the final rate is in the range of 4.75% to 5.25%. When that happens, the final rate approaches 6%. It is a scenario that has hardly been foreseen in financial markets.

A year ago (at the end of November 2021), Fed Chairman Jerome Powell suddenly withdrew his opinion that “inflation is temporary,” causing a major shock to the market. Compared to the change of heart at the time, it is not so unnatural that interest rate rises will continue at a gradual pace without stopping in the January-March quarter. Although this is not the main scenario, it is worth considering as a risk scenario in the direction of yen depreciation.

On the other hand, there is also a risk that the Yen will appreciate more than expected. There are multiple possibilities for this, but it is likely that the Bank of Japan has become hawkish as it transitions to a new system.

At the time of writing, the financial markets were talking about widening the range of variation allowed for the yield curve control (YCC) policy at the December 19-20 monetary policy meeting. But the “Imperial General Headquarters Announcement” is not an increase in the interest rate”.

As a further development (possibly after some comprehensive review, etc.), there remains a policy decision that could be called a real tightening, namely BOJ Colyn. The view that the new system will arrive at such a decision in one leap is by no means dominant, but as reflected in the sharp rise in the yen exchange rate following the BOJ’s decision, the market expects that the BOJ will not be able to tighten its policies after all.

At the moment, the image of the new regime that the market has is that it will not become more helpful than it is at the moment, and although there are multiple candidates for the new governor, which candidate will lead to policy reforms There is no consensus about a It can be said that it is a situation where unexpected things are likely to happen.

Although the possibility of raising interest rates together with the change to the new system (= cancellation of the negative interest rate) may be slightly more likely, it seems to be a big hole in the forecast.

However, in April 2013, the first meeting of Gov. Kuroda after taking office, decided on “quantitative and qualitative monetary easing,” leaving an impression of his strong inflationary philosophy. I wonder if it will happen on the moon.

Of course, given the nature of the Fumio Kishida administration, which is not good at making big decisions, raising interest rates is a heavy burden and unlikely. Rising interest rates should be quite clearly hated by the household sector through housing loan interest rates and other factors.

However, as the majority of foreign exchange market participants did not anticipate the “BoJ interest rate increase” following the cancellation of the negative interest rate policy, it is said that there is little incentive to actively buy the yen. in mind as a risk it causes.

Editing: Kazuhiko Tamaki

*Based on information up to 21 December.

(This column was posted on the Reuters Forex Forum. It is written based on the author’s personal opinion.)

* Daisuke Karakama is Mizuho Bank’s Chief Market Economist. After graduating from Keio University’s Faculty of Economics in 2004, he joined the Japan External Trade Organization (JETRO). In 2006, he was seconded to the Japan Center for Economic Research, and in 2007, he was seconded to the Directorate-General for Economic and Financial Affairs of the European Commission (Belgium). From October 2008, Mizuho Corporate Bank (now Mizuho Bank). When he was seconded to the European Commission, he was involved in the preparation of the EU’s economic outlook as the only economist from Japan. His publications include “European Risks: Japaneseization, Yenization, Bank of Japan” (Toyo Keizai, July 2014), “European Central Bank ECB: From Organization, Strategy to Banking Supervision” (Toyo Keizai, November 2017 Moon). Many appearances in the media such as newspapers and television.

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