Download Forex Medium-Term Outlook

Forex Medium-Term Outlook
30 June 2015
Mizuho Bank, Ltd.
Forex Division
【Contents】
Overview of outlook ・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・P. 2
USD/JPY Outlook – U.S. rate hike speculations shift from “when” to
“how many times”.
Contemplating the Real Effective Exchange Rate: Interpreting BOJ Governor Kuroda’s Remarks・・ P. 3
JPY supply-demand now and going forward
– Improving current account balance vs. accelerating foreign securities investment・・・・・・・・P. 5
U.S. monetary policies now and going forward
– Rate hike focus shifts from “when” to “how many times” ・・・・・・・・・・・・・・・・・・・P. 6
Following the G7 Meeting
– Three intersecting points of view・・・・・・・・・・・・・・・・・・・・・・・・・・・・・P. 8
Risks to the basic scenario and points to consider for 2016
– JPY weakness may end with 2015・・・・・・・・・・・・・・・・・・・・・・・・・・・ P. 10
EUR Outlook – Market shaken by “risk aversion-driven EUR buying”
CB Monetary Policies Now and Going Forward
– Spreading effects of volatility acceptance statement・・・・・・・・・・・・・・・・・・・・・ P. 12
EUR now and going forward
– Market shaken by “risk aversion-driven EUR buying” ・・・・・・・・・・・・・・・・ ・ ・・P. 14
The Euro zone economy now and going forward
– A false dawn? ・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・ ・ ・・P. 16
Medium-term Forex Outlook
1
Mizuho Bank Ltd.
Overview of outlook
A weak JPY scenario remains in place for the rest of this year for USD/JPY going by supply-demand and interest
rates. The improvement in the trade balance continues to be a risk factor, but as of the present stage, it is merely
lowering the pressure to sell, rather than increasing the pressure to buy. For the rest of this year, this publication
would like to assume that the acceleration in foreign securities investment will prop up the JPY selling trend in basic
supply-demand. However, for 2016, I believe it could become important to consider a different scenario. At the
current time, a consensus seems to be forming that there will be two FOMC rate hikes this year, but the sentiment
regarding the subsequent pace of rate hikes is clearly dovish. Once policy firming begins, the monetary policy
focus will shift from “when” to “how many times,” but if the FRB goes ahead with rate hikes while the global
economy is weak, USD will strengthen along with it, and there is deep-seated concern that the U.S. economy may
face headwinds. This scenario has been pointed out by some senior FRB officials as well as the IMF. Again, Japan
will hold an election for the House of Councillors in July 2016, while the U.S. presidential elections are scheduled
for November 2016, and there is some concern that the interests of both countries will coincide on a currency
policy that favors the strengthening of JPY against USD. Under such conditions, the FRB’s normalization process
is unlikely to proceed smoothly (it could even be suspended depending on the situation), and 2016 may be a year
for reevaluating the straight-forward scenario of “USD purchase betting on the gap between local and U.S.
monetary policies.” If so, this year may be the turning point for the JPY depreciation trend.
Regarding EUR, on the other hand, despite the increasing degree of confusion associated with the Greece
situation, factors led by short-covering have kept EUR robust amid the dissipation of the “epic speculation” that has
been depressing EUR forex rates recently. These movements are in line with this report’s assumptions, and the
same kind of movements are likely to be repeated going forward. Of course, there is unlikely to be a change to the
gap between the monetary policies of the FRB and ECB for the time being, and given that the Greece crisis is likely
to continue making itself felt, it is inevitable that EUR will have a heavy upside. At least to the extent that the FRB’s
normalization process continues, it appears that carry transactions associated with EUR fund procurement will be a
factor depressing EUR. However, as this publication has stubbornly argued for some time, given the fundamental
factors that the Euro zone is recording the world’s largest trade surpluses and has a high level of real interest rates,
it would be wise to consider EUR plunges as being linked with subsequent surges, and the reality of this pattern
has been demonstrated by market movements during the April-June period. If U.S. economic conditions
deteriorate following the FRB’s interest rate hike, causing the normalization process to show signs of shakiness,
EUR is likely to become firmer.
Forecast table summary
Jan-Jun 2015
(Actual)
115.86 ～ 125.86
(122.43)
2015
Jul-Sep
121 ～ 127
(124)
2015
Oct-Dec
122 ～ 130
(125)
2016
Jan-Mar
122 ～ 130
(126)
2016
Apr-Jun
121 ～ 130
(124)
2016
Jul-Sep
119 ～ 128
(123)
EUR/USD
1.0458 ～ 1.2170
(1.1203)
1.05 ～ 1.15
(1.10)
1.04 ～ 1.14
(1.09)
1.04 ～ 1.14
(1.09)
1.05 ～ 1.15
(1.12)
1.07 ～ 1.17
(1.14)
EUR/JPY
126.94 ～ 145.30
(137.15)
133 ～ 141
(136)
134 ～ 142
(136)
135 ～ 144
(137)
136 ～ 146
(139)
137 ～ 147
(140)
USD/JPY
(Notes) 1. Actual results released on 30 June 2015 around 10am TKY time. 2. Source: Bllomberg & Others. 3. Forecast rates are quarter-end level
Exchange rate trends & forecasts
Medium-term Forex Outlook
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Mizuho Bank Ltd.
USD/JPY Outlook – U.S. rate hike speculations shift from “when” to
“how many times”.
Contemplating the Real Effective Exchange Rate: Interpreting BOJ Governor
Kuroda’s Remarks
No need to read too deeply into Mr. Kuroda’s remarks
In June, JPY veered sharply upward in the FX market following remarks made by BOJ Governor Haruhiko
Kuroda at the House of Representatives Committee on financial Affairs. As USD/JPY slid sharply by about 3yen
following Mr. Kuroda’s remarks, the headlines portrayed them in exaggerated tones such as “remarks aimed at
checking JPY depreciation,” “verbal intervention,” “consideration for the U.S. economy,” and so on, but I do not
believe there is any need to read that deeply into them. Specifically, Mr. Kuroda said, “JPY has fallen to quite a
low level from a real effective exchange rate point of view,” and that “The fact that the real effective exchange rate
has dropped to this level seems to indicate that it would be difficult for it to fall any further under normal
circumstances” (Reuters), but my impression is that these were merely general theories Mr. Kuroda offered when
stubbornly questioned by the opposition (Please note that “real effective exchange rate” is abbreviated as REER
going forward in the publication).
In fact, what Mr. Kuroda said was merely that “under normal circumstances” the REER did not seem likely to fall
any further, rather than anything about what the BOJ thinks of the matter. In other words, he was merely
introducing the theoretical fact1 that is unsustainable for the REER to continue diverging from the long-term
average in a unidirectional manner. On April 19 this year, at a Q&A session following a lecture delivered in
Wayzata in the U.S. state of Minnesota, Mr. Kuroda had said, “I personally don’t think that USD will continue to
strengthen the way it has over the past year” (Reuters, April 20). This remark is quite close in its intent to the
remarks mentioned above, but it did not attract any market attention. I don’t believe, therefore, that Mr. Kuroda
himself intended to say anything special this time.
In the first place, Mr. Kuroda knows best where the authorities of the Ministry of Finance and the BOJ begin and
end when it comes to foreign exchange. If one knows this, it becomes difficult to understand why the BOJ would
express its opinions about the forex market. Anyone who knows the stances of Japan’s policy authorities
regarding forex can see that the official statements on this matter are those expressed by Minister of Finance
Taro Aso on the same occasion: “Regardless of the direction in which JPY moves, slow and steady movement is
desirable. The other desirable trend is stability.” “(Rapid) appreciation or depreciation is not desirable from the
perspective of those in the position of handling foreign exchange.” Nothing more, nothing less.
1 More accurately speaking, his remarks were based on the theoretical relationship that in a world where purchasing power parity (PPP) works based on strict adherence to the
idea of one price for one product, REER will definitely be at a specific level. If the PPP diverges more than a certain extent from the prevalent market rate, the price differential
of goods will at some point exceed transaction costs, so arbitrage transactions that go beyond the level of the country will gain momentum. Let us take ballpoint pens as an
example. Supposing a ballpoint pen cost USD 1 in the U.S. and JPY 100 in Japan. Then the PPP would be USD 1 to JPY 100. If, at this point, the prevalent market rate swings
toward JPY weakness and becomes JPY 200 to USD 1, importing ballpoint pens from Japan would potentially become more advantageous for U.S. residents even after
taking transaction costs into account. For Japan, this would mean an increase in exports to the U.S. and a resulting expansion in trade surplus, which will eventually lead to JPY
strengthening against USD, bringing the exchange rate closer to the PPP.
Medium-term Forex Outlook
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Mizuho Bank Ltd.
Current understanding regarding the REER
Leaving aside what Governor Kuroda really meant,
the fact is that the JPY REER has sunk to its limits
he pointed out. In my Forex Medium-Term Outlook, I
focus on the correlation between REER and the
index of the terms of trade, which is thought to
suggest the equilibrium level of REER. From the
perspective of this correlation, a significant
depreciation of JPY from its present level will not be
theoretically justifiable (see chart).However, in
practice, it is not necessary for the JPY depreciation
to stop short and start reversing without delays at the
level where it should theoretically stop (in fact, this
rarely ever happens). At the very least an acrossthe-board USD strengthening mood may continue until the end of the year in the hope of U.S. rate hikes. Further,
Japanese investors’ foreign securities investments driving JPY sell-off causing the yen to weaken should also be
taken into consideration (This is actually why I retain my forecast of a 130 upper bound for USD/JPY for this year).
Note that the discrepancy between the REER and the terms of trade index is also in the process of being
corrected from the terms of trade against the sharp fall in crude oil prices. With crude oil prices bottomed out,
though, this trend of improvement is likely to stall, which leads to another reason to believe in the possibility of a
further yen depreciation. The sense of an excessive weakening of JPY from the REER point of view is
something that has been clearly felt since the beginning of 2014, and the currency began to stabilize below the
1973 average as early as last November. There seems no good reason, therefore, to reevaluate this level at this
late stage and issue steamed up warnings about it. Of course, it is quite likely that Mr. Kuroda thinks that any
further yen depreciation is undesirable, but that is not a good enough reason to exaggerate the significance of
what he actually said.
If prices increase, REER will also increase
Incidentally, considering the matter calmly, it is not all that surprising that Mr. Kuroda would hint at the increase in
REER (JPY appreciation). This has to be considered against the fact that Mr. Kuroda has so far claimed, based
on the PPP theory, that JPY appreciation is a result of deflation2, or in other words, that the present yen
depreciation is the result of inflation, and it is thus important when considering the change in REER. What brings
about a change in REER is (1) a change in the nominal exchange rate, and (2) a change in the inflation rate. The
increase in inflation expectations as a result of the Quantitative and Qualitative Easing (QQE) policy leads to JPY
depreciation on a nominal basis because future increases in inflation have been factored in. Naturally, REER will
also drop (JPY will depreciate) simultaneously, weighed down by the nominal exchange rate. However, the
increase in inflation expectations (at least according to the present BOJ theory) will boost real inflation in the
future. If the inflation rate increases, the REER, which is the real basis for the concept of foreign exchange rates,
will increase (JPY will appreciate). In sum, in a world where there is a strict adherence to one price for one
product, and purchasing power parity works, even if the nominal exchange rate decreases as a result of an
increase in inflation rate ((1) above), it will increase on a real basis to the same extent ((2) above), so REER will
be at a certain specific level. Presently, based on QQE, the path (1) has progressed, but (2) has not done so very
well. However, as Mr. Kuroda is in a position to forecast a future acceleration in price growth, it is theoretically
very natural for him to insist that REER will increase along the path (2).
Rather, in the FX market, where instinctive reactions are the norm, such theories are not thought out properly.
However, at least in the case of Governor Kuroda, rather than assuming that he has had any specific change of
heart or any intent of manipulating the markets, it is quite possible that he simply made a remark that was very
natural for him. As Minister in charge of Economic Revitalization Akira Amari said, “his intent was conveyed to the
market in a somewhat distorted form.” This seems to be closer to the truth.
2 For instance, at a lecture on the topic “Invitation to the 2% target” at a Nippon Keidanren (Japan Business Federation) Board of Councillors meeting on February 25, 2014.
At this lecture, Mr. Kuroda said using “The Forex Rate and the Purchasing Power Parity (exhibit 8)” that “Even on the forex side, while other key countries attain an inflation
rate of 2% per year or so based on the global standard, Japan has continued to be in deflation. This is why JPY appreciation has continued as a trend.”
Medium-term Forex Outlook
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Mizuho Bank Ltd.
Can USD strength be fought against in the first place?
Of course, given that the market interpreted Mr. Kuroda’s
remarks as an attempt to deter JPY depreciation, the
truth does not matter, and the concerned authorities may
simply be regretting having said the wrong thing in
retrospect, having already caused market turmoil.
However, if the real intent was not to guide JPY toward
appreciation, and the markets simply reacted on their
own, the present scenario could be considered a good
opportunity to buy on the dips, and what is more, the
acceleration of JPY depreciation since late May is mainly
a result of the appreciation of USD, and any factors
related to the Japanese side are better considered secondary. The exhibit shows the year-to-date spot returns for
G10 currencies. As of the end of 1H of 2015, all currencies except for CHK and GBP have fallen against USD. Of
these various currencies, the margin of depreciation has been the smallest for JPY (this may have something to
do with the fact that all the currencies except JPY that have depreciated against USD have gone through a
monetary policy easing of some sort this year.) Trends in the forex market at the moment are mainly based on
USD purchase rather than on JPY sale, so even if Japan were to take “deterrent” actions, it is difficult to say to
what extent it will be able to fight USD strength.
JPY supply-demand now and going forward – Improving current account balance
vs. accelerating foreign securities investment
Basic supply-demand balance suggests end to JPY depreciation
In June, Japan’s Balance of Payments was published. As usual, I would like to check up on the basic supplydemand balance3 (simply referred as “basic supply-demand” onwards), which I use in this report as a guide
when formulating forecasts. The April current account balance was a surplus of +JPY 1.3264 trillion, which fell
somewhat short of the midpoint of market forecasts (+JPY 1.6874 trillion), but was the tenth consecutive month
of surplus. The pattern seems to be that, despite continuing to be weighed down by the trade deficit (-JPY 146.2
billion), the enormous primary income surplus (of +JPY 2.1971 trillion) pushes up the overall current account
balance – giving an ever stronger sense that Japan is a “mature creditor nation.” In this publication, in order to
understand the direction of USD/JPY, I have been using the basic supply-demand trend (four-quarter averages)
as a guide, and in this connection, I cannot but say that the recent weak-JPY trend is in a rather precarious
position. However, as shown in an exhibit later in this report, the year-to-date basic supply-demand does not
indicate an unrelieved trend of net JPY selling, so going by experience, the market mood seems to be shifting
toward an end to JPY depreciation.
Situation does not warrant declaring that supply-demand balance points to JPY selling
The exhibit shows a close-up of the basic supplydemand since 2013. It is evident that JPY selling
peaked in 1H of 2014, and that the supply-demand
balance has changed markedly since then.
Regarding the basic supply-demand balance, let us
compare the total for January-April this year (April is
the recent-most month for which we have clear
information) and 2H of 2014 (July-December). On
the side of JPY purchases, while domestic securities
investment dwindled down, the current account
surplus expanded and made up for the shortfall. On
the side of JPY sales, while direct investments
(arrived at by netting investments in Japan and
investments by Japanese investors abroad)
dwindled, foreign securities investments accelerated
and made up for the shortfall. As a result, the total
3 While balance of payments statistics are a sum of current account balance, direct investment, and outward/inward securities investment unassociated with depositary
financial institutions and government entities, the statistics are adjusted to calculate the fundamental demand-supply balance by excluding investment income that remains
overseas in the form of foreign currencies. Essentially, the fundamental demand-supply balance focuses on only the items that are likely to have a direct impact on forex to
provide an image of the demand-supply situation. Excluding the “JPY depreciation bubble” period of 2005-2007, when JPY carry trade transactions and other speculative
transactions surged to their peak, the direction of changes in the fundamental demand-supply balance have generally corresponded to the direction of changes in USD/JPY.
Medium-term Forex Outlook
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Mizuho Bank Ltd.
basic supply-demand for the January-April period this year was -JPY 904.4 billion, which amounts to a small net
sale of JPY and suggests JPY depreciation. However, the situation at this point is beginning to discourage any
categorical declaration that the basic supply-demand balance points to JPY selling.
Improving current account balance vs. accelerating foreign securities investment
Given current conditions, when formulating the direction of the basic supply-demand going forward, the key is to
understand whether to give the impact from the improvement in current account surplus or that from the
acceleration of foreign securities investment more weight. With regard to the former, there is strong suspicion that
the improvement in the trade balance as a result
of lower import value against cheap crude oil
prices may have peaked out in January-March
this year. Given that crude oil prices have
recovered since mid-March and USD/JPY has
soared simultaneously, the current account
surplus seems unlikely to keep up the pace of
expansion seen over the past half a year. As it is,
the trade balance for the entire year is not very
likely to turn positive (trade surplus) simply owing
to the fall in crude oil prices4. Crude oil prices have
already begun to recover, and the price will be further inflated owing to the exchange rate effect, so the situation
does not warrant expecting too much of an improvement in the trade balance.
Foreign securities investment posted net purchases for most months during the 14-month period from April last
year through May this year, with the exception of December last year and April this year. What is more, the pace
of these net purchases is quite high, at over JPY 2 trillion per month on average. As the exhibit shows, this trend
is being driven by banks and trust banks (trust accounts), which register pension fund investments, and which
have posted net purchases for all 14 months in a row as of currently available information. There is no doubt that
policy factors, such as the public pension reforms, are behind this trend, but the bigger background factor is the
gap between the U.S. and Japanese monetary policies. So long as the FRB’s main scenario involves a rate hike
within the year, one can logically assume that foreign securities investment will influence the basic supplydemand in the direction of JPY sale. To look at it another way, if the pace of rate hikes is too slow (or in an
extreme scenario, if policy firming comes to a stop after the first rate hike), the aforementioned trend could be
reversed.
To summarize the above, the main highlight with regard to the basic supply-demand from 2H of this year onward
will be to see whether the acceleration in foreign securities investment can outdo the improvement in the current
account balance, and this will be the key to forecasting the direction of USD/JPY. I think that the aforementioned
basic supply-demand trend will be necessary at least for USD/JPY to stabilize at above 125. However, as I will
mention also in the future section on risk scenarios, if the FRB’s normalization process is derailed by concerns
over USD strength, foreign securities investments will slow down, and the JPY appreciation trend, which this
report assumes will begin early next year, may begin sooner than that.
U.S. monetary policies now and going forward – Rate hike focus shifts from
“when” to “how many times”
FOMC and SEP – No change in basic scenario
At the FOMC meeting held on June 16-17, no policy changes were made. The official statement changed its
assessment of current economic conditions from the previous (April) “economic growth slowed during the winter
months, in part reflecting transitory factors” to “economic activity has been expanding moderately after having
changed little during the first quarter.” This is the first time in the five meetings since last December that the
assessment has been upgraded. Having said that, dovish sentiments continue to be expressed with regard to
categories that reflect corporate consumption/investment appetite such as capital investment and exports, and
this is thought to be one of the reasons the committee could not raise the federal fund rate in June.
4 I make my estimate based on the following method. The average price of crude oil was USD 96/barrel in 2014, but USD 53/barrel for the January-April 2015 period, which
is a 44% fall. Let us assume that the price of crude oil levels off at USD 53/barrel for the rest of this year. The elasticity coefficient for mineral fuels is 0.73 per 1% rate of
change in crude oil price, so the trade deficit will shrink by 44% x 0.73 x JPY 28 trillion ≒ JPY 9 trillion. Given that the trade balance for 2014 was -JPY 12.8 trillion, it is
unreasonable to expect that the trade balance will turn positive simply based on the fall in crude oil prices.
Medium-term Forex Outlook
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Mizuho Bank Ltd.
In the quarterly Summary of Economic
Projections (SEP) that was being FRB Economic Outlook FOMC Date
2015
2016
2017
Longer run
awaited, the real GDP projections for
Sep-14
2.6 to 3.0
2.6 to 2.9
2.3 to 2.5
2.0 to 2.3
Dec-14
2.6 to 3.0
2.5 to 3.0
2.3 to 2.5
2.0 to 2.3
2015, 2016, and 2017 were 1.8 to 2.0%,
GDP
Mar-15
2.3 to 2.7
2.3 to 2.7
2.0 to 2.4
2.0 to 2.3
2.4 to 2.7%, and 2.1 to 2.5%,
Jun-15
1.8 to 2.0
2.4 to 2.7
2.1 to 2.5
2.0 to 2.3
Sep-14
5.4 to 5.6
5.1 to 5.4
4.9 to 5.3
5.2 to 5.5
respectively. Since the 2015 JanuaryDec-14
5.2 to 5.3
5.0 to 5.2
4.9 to 5.3
5.2 to 5.5
Unemployment
Rate
Mar-15
5.0 to 5.2
4.9 to 5.1
4.8 to 5.1
5.0 to 5.2
March period GDP posted negative
Jun-15
5.2 to 5.3
4.9 to 5.1
4.9 to 5.1
5.0 to 5.2
growth, the latest projections seem to
2.0
Sep-14
1.6 to 1.9
1.7 to 2.0
1.9 to 2.0
Dec-14
1.5 to 1.8
1.7 to 2.0
1.8 to 2.0
2.0
have been significantly downgraded
Inflation
Mar-15
1.3 to 1.4
1.5 to 1.9
1.8 to 2.0
2.0
compared
with
March.
The
Jun-15
1.3 to 1.4
1.6 to 1.9
1.9 to 2.0
2.0
unemployment rate projections have （Source）FRB
been slightly upgraded (indicating
deterioration) to 5.2-5.3%, 4.9-5.1%, and 4.9-5.1%, respectively, from the March 5.0-5.2%, 4.9-5.1%, and 4.85.1%, respectively. The inflation rate projections (PCE deflator), which are of interest, were 0.6-0.8%, 1.6-1.9%,
and 1.9-2.0%, respectively, and have not changed very much from the previous time. Overall, therefore, though
there were some slight revisions, the bigger picture remains unchanged compared with March, namely – the
potential growth rate, natural unemployment rate, and the inflation rate in line with these, will begin accelerating in
2016, and will attain convergence with the equilibrium levels in 2017. To go further, the big change compared with
March could be that the negative growth for the January-March period eliminated any chance of a rate hike in
June. However, because this negative growth was due to one-off factors such as adverse weather conditions
and strikes, they do not affect the bigger picture, and many members believe that a rate hike in September may
be reasonable.
Weakening predictions about “how many times”
Policy interest rate outlook as of each year end (median)
In the predictions of members regarding the timing and
FOMC Date
2015
2016
2017
Longer run
pace of policy firming, 15 out of 17 members predicted
Sep-13
1.00%
2.00%
n.a.
4.00%
a rate hike in 2015. Looking at the specifics of each
Dec-13
0.75%
1.75%
n.a.
4.00%
member’s prediction (also known as the dot chart), the
Mar-14
1.00%
2.25%
n.a.
4.00%
midpoint of the target range for the federal funds rate
Jun-14
1.125%
2.50%
n.a.
3.75%
Sep-14
1.375%
2.875%
3.75%
3.75%
as of the end of each year was 0.625%, 1.625%, and
Dec-14
1.125%
2.50%
3.625%
3.75%
2.875%, respectively, for 2015, 2016, and 2017. The
Mar-15
0.625%
1.875%
3.125%
3.75%
projection for 2015 remains unchanged from the
Jun-15
0.625%
1.625%
2.875%
3.75%
previous time, but those for 2016 and 2017 have been
（Source）FRB
downgraded by 25 basis points (bp) each from last
time’s 1.875% and 3.125%, respectively. As for the timing, it looks like opinions are converging at twice this year,
which gives a rather hawkish impression considering that the 2015 GDP outlook has been downgraded. As for
“how many times,” one cannot help feeling that pessimistic views are gaining ground, which is somewhat more
dovish in tone. I explain in greater detail below, but when it comes to FX market trends, there may be no big
difference whether a rate hike takes place in September or December, rather, the key point in formulating
forecasts for 2016 and onward, it may be important to consider that dovish sentiments are gaining with regard to
the question “how many times” rate hikes can be implemented.
The waning importance of the question “when”
At FRB Chair Janet Yellen’s press conference, it was emphasized that the timing of the first rate hike must not be
given undue importance, and hinted that the pace of rate hikes may be gentle. The important question still
remains “how many times” rather than “when.” The answer to “when” can be narrowed down to two options –
September or December, and so long as the central banks of Japan and Europe remain firmly on
accommodative monetary policy paths, USD remains likely to soar regardless of which option is chosen.
This is exactly what FRB Governor Lael Brainard and the IMF’s staff report on the U.S. are worried about5, and it
finally boils down to until when the U.S. economy can put up with USD strength. According to the medium to
long-term forecasts of many economists, the FF rate will not return to the level it was at before the financial crisis
began (5.25%) even after the present normalization effort has been completed. Many say that the neutral rate
level the FRB is conscious of (3.75%) may be the peak. However, given the present level of noise (remarks by
senior U.S. government officials) regarding the present strength of USD and the impact it has on actual hard data
(inflation rate, exports, and eventually even indicators such as the GDP), even 3.75% seems much too high. As
per the dot chart, the FF rates will be raised by a total of 100 bp over the period of one year from the end of 2015
to the end of 2016. Assuming a 25 bp hike each time, this makes for four rate hikes. In other words, once every
5 Please see the June 8, 2015 Market Topic titled “Can the FRB really implement an early rate hike.”
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Mizuho Bank Ltd.
quarter. However, it is difficult to abruptly take for granted that the U.S. economy is strong enough to withstand
this pace of rate hikes.
Just as there is a consensus regarding the fact that policy firming may begin either in September or in December,
it is likely that another consensus will begin to take root in the near term – one regarding the fact that continued
rate hikes following the first one may be difficult. This time, the fact that the 2015 interest rate prediction remained
unchanged from March at 0.625% despite the downward revision of GDP can be seen as a rather hawkish
move. It was therefore unsurprising that USD purchase accelerated. However, in reality, thanks to a dovish
interpretation of events, USD weakened following the FOMC meeting. This may be a sign that the market’s focus
is beginning to shift from “when” to “how many times” the rate will be hiked from 2016 onward, and this mood will
only become stronger going forward. Since early last year, I have believed that this mood will impact the trend of
USD/JPY, too.
So far, in formulating forecasts for all currency pairs, the gap between the monetary policies of the currency in
question and USD has been as a major background factor, and “so long as the FRB continues with its
normalization efforts, USD will continue to strengthen” has been the golden rule. However, this scenario may
have to be reevaluated as we approach 2016. Of course, if policy firming begins in September and it weighs
down the U.S. economy more than expected during the October-December period, the timing for reevaluation
may even be brought forward to before the end of this year.
Following the G7 Meeting – Three intersecting points of view
The conclusion seems to be that USD appreciation is still acceptable as of now
The G7 meeting of finance ministers and central bank governors was held on May 28 and 29 in Germany. Forex
market participants had been watching closely for each country’s reaction to USD appreciation, and while
Japanese Minister of Finance Taro Aso did express concern regarding the increase in JPY rate volatility, the G7
as a whole did not indicate any special degree of problem awareness related to forex rates. The Greek problem
and concerns surrounding it were taken up for discussion, and coinciding with this, IMF Managing Director
Christine Lagarde admitted the possibility of Greece’s exit from the Euro in an interview for a German newspaper.
However, the G7 itself, did not build consensus or issue any joint statements.
After Finance Minister Taro Aso said following the G7 meeting that “foreign exchange rates were not discussed at
the G7 meeting” (Nikkei, May 29), there was a time when USD purchases increased, but leaving aside whether
this is really true, one can at least say that following the recent G7 meeting, the forex markets’ consensus seems
to be that “USD appreciation is still permissible under U.S. currency policy.”
Three intersecting points of view regarding USD strength
As mentioned above, the recent JPY depreciation is ultimately the result of USD appreciation, so it would be
difficult for remarks by senior Japanese officials or any other Japanese-side actions to succeed in bringing the
rate down. If so, so long as the U.S. Department of Treasury’s stance of permitting USD appreciation does not
change (as I will explain later, there is reason to believe they may not be permitting it), it will be important to see
how strong the voices of non-USD economies including Japan are. More specifically – whether there are any
other countries/regions apart from the U.S. that are adversely impacted by USD strength. And ultimately, the
dynamics between the various currencies in the forex markets will change based on how effectively the various
concerned parties’ expressions are reflected at economic diplomacy forums such as G7 and G20.In this regard,
let us take a look at the circumstances of the three
key regions of the U.S., Europe and Japan.
Regarding Japan’s currency policy, the honest view
that any further depreciation of JPY would be
problematic has been indirectly expressed. Given
that there are signs of a bottoming out of crude oil
prices, any further depreciation of JPY will
accelerate the draining away of income from Japan
based on the deterioration in the terms of trade, and
this damage to real income is likely to dampen the
economy. The reason the economy slowed down
sharply in 2H of 2014 was not just in reaction to the
consumption tax hike, but also due to deterioration in
purchasing power as a result of JPY depreciation.
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On the other hand, Europe’s position is that the weaker their domestic currency, the better, so they see no need
to caution about excessive USD appreciation against EUR and wake sleeping dogs. Taking into account the
recent status of Euro zone current account balances, it would not be surprising if the U.S. were to express
serious criticism of Europe at any time now, but the situation continues to be extremely delicate. Now that inflation
expectations and the actual inflation rate have finally begun to rise, it seems impossible that Europe would
deliberately bring up the issue of forex rates. As one can see plainly from the chart, the appreciation of USD
since last year, has essentially been a development led by the depreciation of EUR. Of course, it is also true that
the weakening of JPY during this time also contributed to USD strength, but when JPY weakened sharply during
2013-2014, the accompanying appreciation of USD was limited. This is because, coincidentally, EUR/USD had
been appreciating during that time, so ultimately, the overall USD rate trend was regulated more by EUR trends
during the past one year as the real effective USD rate is affected by EUR rates to a greater degree.
More specifically speaking, the weight of different currencies affecting the real effective USD rate (broad based)
as published by the Bank for International Settlements (BIS) is China (CNY) 20.9%, Euro zone (EUR) 17.4%,
Canada (CAD) 13.3%, Mexico (MXN) 11.5%, and Japan (JPY) 8.8%. During 2013-2014, CNY and EUR, the top
two currencies that affected USD were strengthening against USD, and this neutralized not just the steep
depreciation of not just JPY but also CNY and MXN against USD (see chart below, left graph). However, in the
present phase of USD appreciation, almost all the currencies heavily affecting USD have been depreciating, with
EUR’s movements being particularly dramatic (see chart on the previous page, right graph). So long as the U.S.
takes no serious action to contain this USD strength, and Europe also finds the situation comfortable, regardless
of Japan’s situation, a dramatic reversal of the JPY depreciation trend seems rather difficult. There is no way of
knowing the exact truth of the situation, but guessing from the G7-related reports published last week, Japan
seems rather isolated in its concern regarding USD appreciation.
Of course, there is no guarantee that the U.S. will remain silent
Of course, there is no guarantee that the U.S. will continue to remain silent. Rather, one can speculate that it is, in
reality, simply “enduring” rather than “permitting” USD appreciation at the moment. USD appreciation over the
past one year is clearly a trend that reflects the difference in monetary policies between the U.S. and the other
countries, a fact that is acknowledged by the Semiannual Report on International Economic and Exchange Rate
Policies. So long as the present USD appreciation is rooted in the monetary policies of the U.S. itself, there is
automatically a limit to the extent other countries’ weak currencies can be criticized. However, as I will explain
below, the negative impact of USD strength is clearly beginning to manifest itself, and if the trend continues, the
U.S. Treasury Department would be forced to change its stance on currency policy, as would the FRB on its
monetary policy. Looking at the U.S. GDP, the slowdown in real exports is quite clear, and even though this is
partly due to the bad weather, there is no question that USD strength is beginning to affect the macroeconomy.
Frankly speaking, I think one of the big reasons the FRB is currently aiming for a rate hike could be because the
previous FRB chairman had already begun the dialog. The logic behind a rate hike is still not clear otherwise.
Given that the economy could slow down as a result of USD appreciation, and the inflation rate could slacken
with a time lag, there is no reason to implement a hasty rate hike. Until the first rate hike takes place, the U.S.
Secretary of Treasury may also remain silent out of consideration for the FRB’s reputation, but it would be
sufficient if he expresses his true position after that, given the negative effect on actual economic performance. If
USD continues to rise following the September rate hike, the October Semiannual Report on International
Economic and Exchange Rate Policies, for instance, could have a somewhat more earnest tone. At any rate, it is
unlikely that the world’s currencies will move in a direction that is not acceptable to the U.S., which governs the
key global currency. Given an increasing number of signs that USD strength is weighing down the U.S. economy,
the trend of USD strength will have to stop at some point. I think that the timing will be early next year, and
therefore, I think that 2015 may be the turning point for the JPY depreciation against USD scenario.
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Risks to the basic scenario and points to consider for 2016 – JPY weakness may
end with 2015
U.S.-related risks
As I have already said, this publication believes What could come in the way of JPY weakness/USD strength in FY2015
that JPY weakness/USD strength will be the main
Risk factors
Remarks
Historically, USD has tended to drop sharply
scenario at least for the rest of this year and peak
1 Historical anomaly
right after a FF rate hike
out next year because the basic supply-demand
USD strength is acceptable as a currency
U.S.
2 Deterring action by the U.S.
continues to point to net JPY selling. Of course,
policy but how about a monetary one…?
Rate hikes end after first round due to the
there are also some risks (chart). I would first like
3 U.S. economy's setback
negative impact on housing market, etc.
to consider the U.S.-related risks. As I consistently
Rapid improvement in Japan's trade balance.
Portfolio investment assets decrease.
point out, (1) anomalously, USD has historically
Rapid improvement in supply
had a very high probability of falling immediately Japan 4 and demand environmant Portfolio investment liabilities increase. Is it
up to crude oil price? Terms of trade should
following a rate hike by the FRB. This time round,
be on focus
Waver in JPY weakness as a currency policy.
the U.S. is the country including among emerging
5 Deterring action by Japan
House of Councillors elections in July 2016
economies and resource-rich economies that is
Diverse geopolitical risks and other
poised to be the earliest to implement a rate hike, Other 6 Others
unpredictable events generally lead to
windbacks of JPY short positions
so an anomaly of the above kind has a relatively
low likelihood of happening. However, it is in the Source: Compi l ed by Ka ra kama
nature of forex markets to “buy the rumor and sell the fact,” so the possibility can certainly not be ignored.
Risk factors (2) and (3) are important for all currency pairs, not just USD/JPY. Going by the midpoint of
projections by FOMC members, the FRB is expected to raise the FF rate by 25 bp per quarter. Even before this
policy firming has begun, noise related to USD strength has risen considerably, and its negative impact is
beginning to be backed up by real data such as in the deterioration of corporate earnings and the expanding
negative contribution from net exports. If USD continues to strengthen alongside rate hikes, it would be worth
considering the risks of the normalization process stalling. The May 28 IMF staff report on the U.S. and the June
2 lecture by FRB Governor Brainard cautioned about the seriousness of the risk of U.S. economic slowdown due
to rate hikes and USD appreciation. These warnings should be taken very seriously.
Japan-related risks
Regarding Japan, I would like to consider the (4) rapid improvement in supply-demand to be a risk factor. As
mentioned above, the net sale of JPY has recently been gradually shrinking. As of now, the flow continues to
amount to a net sale of JPY thanks to the enormous flow of foreign securities investment, but only barely so.
Going forward, if the trade surplus (current account surplus) expands or foreign securities investment slows down,
it could turn into a net purchase of JPY. I think that the improvement in trade balance may have peaked out
during the January-March 2015 quarter, but if crude oil prices were to fall further going forward, the global
economy may post a surprising recovery and exports may accelerate. In such a scenario, the supply-demand
may become more inclined toward a net purchase of JPY. What is more, when it comes to foreign securities
investment trends, policy-related factors, such as the public pension reforms, tend to have quite a large impact,
and one of the big background prerequisites is for the FRB’s normalization process to remain on track. In this
context, the aforementioned risk factors (2), (3) and (4) have something in common.
Factor (5) continues to smolder in the background giving rise to uncertainties. In the January 2015 Monthly
Economic Report, the December “The Government expects the Bank of Japan to achieve the price stability
target of two percent at the earliest possible time” was revised to “The Government expects the Bank of Japan to
achieve the price stability target of two percent in light of economic activity and prices.” As this shows, the
government and ruling party are now seen both within and outside Japan to have changed their stance regarding
JPY weakness. For this reason, the market has become sensitive to every small word or action from government
officials, and the ground seems to have been prepared for rumors about government efforts to contain JPY
depreciation at every opportunity (the fuss over Governor Kuroda’s remarks mentioned at the start of this report
is a case in point). In particular, if one considers that a national election (House of Councillors election) is
scheduled to take place in July 2016, the government will find it even more difficult to be seen as supporting JPY
weakness starting early next year. How much more difficult it gets will be an important risk factor when
forecasting JPY.
Points to consider for 2016
Having taken stock of the various risk factors for 2015, I would like to sort out the points that must be taken into
account for 2016 in relation to U.S. and Japanese currency and monetary policies. First, with regard to U.S.
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General image for fiscal 2016 outlook
currency policies, given that a
Item
Comment
Directionality
Limit to tolerance of USD strength? Focus on
presidential election is scheduled for U.S. (1) Currency policy
JPY strength/USD weakness
period before/after presidential elections
November 2016, there is concern that
Shift from “when will they” to “how many times
(2) Monetary policy
JPY strength/USD weakness
can they”
U.S. industries will be prone to
Upper House elections in July 2016. Difficult to
JPY strength/USD weakness
complain if USD continues to Japan (3) Currency policy
put up with real wage decline?
Realistically impossible to rule out given
strengthen. If that becomes the case,
(4) Monetary policy
JPY weakness/USD strength
prospective April 2017 consumption tax rate hike
the U.S. Department of Treasury, Other (5) Other disrupting factors Greece-related chaos, ECB exit strategy, crude oil Depending on the situation
price plunge, anomaly, etc.
which has remained silent so far, will Source: Compi l ed by Ka ra ka ma
have to change its currency policy
stance, and it is very possible that a message of some sort will be sent out to contain the trend of USD
appreciation. Again, as I already explained, if the FRB begins policy firming this year, the focus of discussions will
probably shift from “when” to “how many times.” Over the past two years at least, it was reasonable based on the
simple dualism between “currencies that can be normalized” vs. “currencies that cannot be normalized” to predict
USD appreciation, and that prediction did, in fact, come true. However, once the FRB starts rate hikes, there is no
doubt that the markets will move their attention to “how many times can rate hikes be implemented.” There is still
no consensus in the markets about how many times rate hikes will really be possible before the process stalls, or
whether the process will run its course without stalling until the neutral interest rate of 3.75% is reached. I agree
with Governor Brainard and the IMF’s staff report on the U.S. in thinking that USD will appreciate further as a
result of a rate hike before the end of this year, and in 2016, the Committee may be forced to end the hikes as
the economy slows down. As a result, I think U.S. monetary and currency policies may begin to distance
themselves from USD strength over next year and predictions based on simple dualisms, which have been
numerous so far, will become more difficult.
With regard to Japan’s currency policy, it is as I have already explained. If one considers that the House of
Councillors election will be held in 2016, there is very little reason for the government to adopt measures that
promote JPY depreciation and the suppression of real wages as a result of an increase in prices. What is
important is that this currency policy circumstance that Japan is placed in makes Japanese interests coincide
with the U.S. currency policy interests. Historically, Japan has never challenged JPY depreciation, so it has been
very rare that U.S. and Japanese interest have coincided, but my present prediction is that it will be politically
difficult to promote JPY depreciation against USD in 2016. Given these circumstances, the BOJ is also likely to
take into account these various currency-policy background factors in its monetary policy operations. In this
report, I have assumed that an additional monetary easing will be implemented in October this year for technical
reasons related to the purchase of government bonds, but given that government and ruling party officials have
not been able to curb anxiety over JPY weakness even after the end of the April national elections, I am
beginning to think that the possibility of such an easing is gradually decreasing. However, given that another
consumption tax rise is scheduled for April 2017, the BOJ is unlikely to tighten its monetary policy at least until the
latter half of 2017. Therefore, there is unlikely to be any move to taper during 2016, so as far as monetary policy
goes, the factors seem to point to a continued JPY weakness/USD strength.
Amid a general lack of confidence in the FRB’s normalization process, if JPY depreciation against USD meets
headwinds from political circles as well, it does seem that this may be the last year for JPY depreciation, and one
may need to begin forecasting a reversal in forex trends for 2016.
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EUR Outlook – Market shaken by “risk aversion-driven EUR buying”
CB Monetary Policies Now and Going Forward – Spreading effects of volatility
acceptance statement
Major market swings without external causative factors
The June 3 ECB Governing Council meeting decided to keep the policy interest rate (interest rate on main
refinancing operations (MROs)) at 0.05%, the upper limit (the interest rate on the marginal lending facility) at
0.30%, and the lower limit (interest rate on the deposit facility) rate on the deposit facility at -0.20%. As a result,
the interest rate corridor (the difference between the upper limit and the lower limit) was maintained at 0.50
percentage point. The introductory statement to the post-meeting press conference mainly replicated the
statement after the April meeting (as explained below, there was a bit of downward adjustment to the
expressions used to describe economic growth), and statements regarding existing policies were limited to those
emphasizing “the full implementation” of those policies.
However, in response to ECB president Mario Draghi’s press conference, there was considerable selling of
German government bonds and other Euro zone government bonds (increasing yields), and EUR sharply
appreciated. As described below, Draghi’s statement (“we should get used to periods of higher volatility”) was
interpreted as an acceptance of rising yields, and that elicited EUR buying. In this regard, Draghi might be
considered to have been somewhat careless insofar as he heads a central bank responsible for promoting
market stability. In view of the negative interest rate and Grexit situations that have become linked to the “epic
speculation” on EUR depreciation, such statements as Draghi’s “get used to volatility” are clearly liable to
become market moving factors with respect to both bond and currency markets. This report has continuously
argued that EUR is a currency that should be considered worth purchasing based on the fundamentals, but
regarding bonds, given such factors as the continuing implementation of the expanded asset purchase
programme (APP) and what seems to be a slump in Euro zone’s economic growth rate, a sustained rise in yields
would appear unlikely.
Problematic aspects of volatility acceptance statement
While the recent Governing Council meeting can be characterized as uneventful, the part of the meeting
considered significant by the markets was Draghi’s statement – “«we should get used to periods of higher
volatility. At very low levels of interest rates, asset prices tend to show higher volatility.” Given that high volatility
can lead to market instability and can consequently produce a situation detrimental to stable economic growth,
there is room for arguing about whether it was proper to make this kind of statement. The problem is that, in
response to the statement, there was a surge in yields on German government bonds and other Euro zone
bonds and the upswing of EUR intensified. Immediately after the statement, a reporter posed the question – “Mr.
President, one question on that, we have to get used to greater volatility. What are you planning on doing against
that greater volatility? Are you planning on managing the yield curve going forward a bit more, or don’t you [the
ECB] care about greater volatility?” It seems likely that the reporter was just as surprised by the volatility
acceptance statement as I am, and that surprise was probably the reason for the above question. In response,
President Draghi stated that the ECB’s policy objective is simply to maintain price stability and that the ECB has
no intention of changing its policy stance to address volatility-related issues. However, since it is fully possible that
higher levels of market volatility could lead to developments that threaten the stability of the real economy, his
explanation seemed somewhat unconvincing.
Much although not all of the rise in volatility can be considered a side effect of the APP’s implementation, but it
may be that it is difficult for the ECB to directly face this situation. President Draghi has recently pointed out that
numerous factors are contributing to high volatility, including (1) rising expectations of economic recovery, (2)
rising expectations of inflation, and (3) technical problems (excessive dependency on long-term bonds, sudden
bond issues by various countries’ governments, transactions predicated on volatility expectations that themselves
actualize volatility, low liquidity levels, etc.) However, the more effective the APP is, the more it is likely to stimulate
factors (1) and (2), and it is undeniable that the APP is to a considerable extent complicit in promoting the liquidity
problem within factor (3). While placing special emphasis on “the full implementation” of existing policies, Draghi
characterized tapering and exit strategies (QExit) as “a high-class problem” and dismissed the possibility of such
measures in the near future, saying – “We have still a long way to go.”
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Doubts about the economic growth outlook
ECB Staff Outlook June 2015
The ECB staff macroeconomic projections
2014
2015
2016
have been revised (see chart). The Euro zone’s
Harmonized index of consumer prices (HICP)
0.4
0.2～0.4
0.9～2.1
real GDP growth rates in 2015, 2016, and 2017
（previous：DEC 2014）
(▲0.3～0.3） （0.8～2.2）
are expected to be 1.5%, 1.9%, and 2.0%
Real GDP
0.9
1.1～1.9
0.5～3.3
（previous：DEC 2014）
（0.8～3.0）
(1.1～1.9）
respectively, almost unchanged from the March
Consumption expenditure
1.0
1.9
1.6
2015 projections (1.5%, 1.9%, and 2.1%). The
Government expenditure
0.7
0.7
0.7
HICP projections are 0.3%, 1.5%, and 1.8%,
Gross domestic fixed capital formation
1.2
1.9
3.5
and those figures include an upward revision to
Export (goods & services)
3.8
4.2
5.4
the 2015 figure in the March projections (0.0%,
Import (goods & services)
4.1
4.8
5.8
(Source )ECB （Note）ECB projects EUR/USD ra te to l ea ve uncha nged a t 1.12 for 2015-2017
1.5%, and 1.8%). While the revised projections
are almost the same and the previous ones, there are some doubts about certain parts of them.
(％)
2017
1.0～2.6
（1.0～2.6）
0.3～3.7
（0.9～3.3）
1.6
0.8
3.9
5.6
5.9
Regarding the real GDP growth rate, since the rate of increase in crude oil prices has been somewhat faster than
the ECB’s assumption, I believed that, given that real income improvement will be delayed, there might be a
slight downward adjustment to the 2015 GDP growth rate projection. In fact, the 2015 inflation rate projection has
been adjusted upward, and it should probably be recognized the higher inflation rate has the potential for
negatively impacting consumption and investment activities within the Euro zone. Moreover, in response to a
reporter’s question at the press conference (“Are you surprised at all at the pace with which inflation has climbed
back into positive territory?”), Draghi said, “« no we have not been surprised. Inflation came out higher than
market expectations but not higher than our expectations.” In other words, the ECB Governing Council had
assumed that the inflation figures would be stronger than the figures in the projection.
Furthermore, the portion of the post-June Governing Council meeting statement regarding the economic outlook
was “we expect the economic recovery to broaden”, which is somewhat weaker than the corresponding portion
of the post-April Governing Council meeting statement, which was “we expect the economic recovery to broaden
and strengthen gradually.” In this regard, in response to a reporter’s question (“So does that mean that we are
running out of steam already?”), President Draghi said, “there has been some loss of momentum«mostly due to
a weakening of the economies outside the Euro zone.” Given the change to the official statements along with
Draghi’s replies at the press conference, it is quite difficult to comprehend how the 2015 GDP growth projection
made in March can be maintained without adjustment. It is probably wise to be alert to the possibility that the
September projections will make a downward adjustment to the 2015 GDP growth projection owing to
deterioration of real income, etc.
Rare instance of President Draghi ruminating
Numerous questions were posed at the press conference with regard to timely Greece-related issues, and
President Draghi began by insisting that he was not himself in a position to comment. Despite that, after several
stubborn questions about the negotiations between Greece and the Troika, Draghi at one point extended the
standard response to say – “Also because I’m here in Frankfurt, and the negotiations are not taking place here”.
While there have long been expectations that the haircut ratio on collateral for Emergency Liquidity Assistance
(ELA) to Greece will be increased, there was still no decision on this matter made at the June meeting. A
question that cut to the heart of the matter was posed in this regard – “it looks like you're making political
considerations; not willing to interfere in the ongoing political process [even though a haircut adjustment or writeoff may be appropriate].” Draghi did not concede to this accusation, and he restrained himself to simply stating
that the ECB will continue discussing and assessing the situation.
Toward the end of the press conference, a reporter posed a comprehensive question about the financial crisis –
“It's a couple of years ago now since we had the outburst of the European crisis. According to you, what is the
main lesson?” Although President Draghi habitually responds immediately to questions, at this time, he said “the
first [lesson] that comes to mind is that ... well let me step back.” and this rare instance of Draghi ruminating over
a question made a strong impression. Ultimately, he stated that excessively expansionary monetary policy along
with the weakening of financial regulations in the early 2000s caused the financial crisis. He said – “So one
lesson we learned is that we made our financial system stronger.” During the press conference, Draghi also
pointed out regarding the risk of financial systemic instability stemming from protracted easing environment that
such risk should be countered, not with monetary policies, but with macroprudential instruments (essentially
meaning regulations). The question of how important it may be for Japanese financial institutions to increase the
rigor of their systems for managing risks associated with questionable government bonds is currently being
discussed, and the European financial crisis can be considered a good starting point for disseminating the
“government bonds are not necessarily safe” concept. I will postpone the presentation of arguments about this
issue to a later date, but one gets the impression that we have already seen a one-act dramatic demonstration of
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how the flow of contemporary trends is making it increasingly important to supplement strict capital requirements
with provisions to prevent the assumption of unreasonable risks.
EUR now and going forward – Market shaken by “risk aversion-driven EUR
buying”
Why is EUR strong?
Since mid-May, other factors affecting forex market transactions have been overwhelmed by the Greece
situation. Headlines about progress in negotiations have been updated at a dizzying pace, but when EC
President Jean-Claude Juncker and Eurogroup President Jeroen Dijsselbloem make hints about a Greek exit
from the Euro zone, the tension in the forex market reaches unprecedented new heights. The EC and Eurogroup
have been cheering on the Euro zone’s expansion and deepening, and they have seen their role as one of
nipping in the bud any incipient moves by Euro zone countries to leave the zone. The fact that even such
institutions are prepared to wash their hands of the matter is a clear indication of how audacious the Greek
negotiating position has been.
Leaving aside the state of negotiations between
Greece and the Troika (the EC, ECB, and IMF), the
key thing that many market players cannot fully
comprehend is how, despite the tenseness of the
situation, EUR has remained so firm during the MayJune period. Looking at EUR nominal effective
exchange rates (calculated with respect to the Euro
zone’s 20 principal trade partners), for example, one
finds that, despite the chaotic Greek situation, EUR
nominal effective exchange rates bottomed out in midApril and are showing signs of rebounding (see graph).
During the past two months, EUR has been
strengthening against numerous currencies, not just
against USD.
This report has repeatedly articulated its fundamental understanding regarding EUR – given the Euro zone’s
world-leading current account surpluses and high real interest rate levels, EUR is a currency that should be
considered worth purchasing based on the fundamentals. Despite this, EUR has greatly depreciated during the
past year. This has resulted from the rapid-fire introduction of monetary easing policies – from the surprise
interest rate reduction of November 2013 through the quantitative expansion (QE) program launch of January
2015 – and there are strong grounds for suspecting that these policies were introduced with the objective of
guiding EUR downward. Consequently, even though the EUR has retained its fundamental strengths as a
currency, an “epic speculation” centered on the internal-external interest rate gap concept has determined the
course of EUR exchange rates. Looking at the IMM currency futures transactions situation, there were
approximately EUR30 billion (calculated by me) of EUR short positions against USD as of March 2015. This is
the highest such level in three years, since June 2012, when the debt crisis was still smoldering.
The “epic speculation” becomes unsustainable
However, the “performance” of a speculation-driven currency depreciation trend contrary to the fundamentals is
not sustainable. This is because, when we enter situations in which there is a sharp deterioration in market
players’ risk tolerance, the speculative positions must be eliminated. When the speculative positions are gone,
only the strong fundamentals remain. Specifically, the Euro zone recorded a current account surplus of
approximately EUR210 billion in 2014, which is about JPY30 trillion (calculated at the EUR = JPY145 rate
current at the end of 2014). So the Euro zone’s current account surplus is significantly greater than that of Japan,
which peaked at approximately JPY25 trillion in 2007. The Euro zone’s real interest rates cannot be said to be
particularly high at this time – owing to the ECB’s restraint of nominal interest rates by means of QE and the rise
in HICP as the impact of crude oil price drops diminishes – but the government bonds of some peripheral
countries still retain some investment appeal. As soon as speculative EUR selling can no longer be sustained,
the EUR-boosting effects of these fundamental factors will make their appearance.
I have long considered the EUR depreciation situation seen during the past year to be similar to the JPY
depreciation situation of 2005-2007, when JPY carry trade transactions surged to their peak. The accumulation
of EUR short positions since spring 2014 has, both in speed and scale, surpassed the accumulation of JPY short
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positions in the 2005-2007 period. Looking at the net number of IMM currency future short and long contracts,
regarding JPY, one finds that net shorting began on February 8, 2005, when the net number of shorts rose to 14,290 contracts, and peaked at -188,077 contracts on June 26, 2007. So, JPY selling reached its peak in a
period of about two years and four months. Net shorting of EUR began on May 13, 2014, when the net number
of shorts rose to -2,175 contracts, and it was approaching its peak on March 31, 2015, with the net shorts
amounting to -226,560 contracts. So, the EUR shorting has reached a peak in about 10 months, and the scale of
the shorting is considerably greater than that of the JPY shorting. These figures give a clear impression about
how intense the current EUR-depressing speculation has been. In brief, my fundamental understanding of EUR
is that “such rapidly created speculative positions cannot be sustainable. Accordingly, one should anticipate a
turn-around in EUR.” In fact, the EUR short positions have begun gradually dissipating since this April, and the
pace of dissipation has further accelerated since late May, when the Greece situation began becoming
increasingly tense. The EUR short position was USD19.46 billion on June 9 but as of June 16 had plummeted to
USD12.56 billion, the lowest level in 11 months, since July 15, 2014. The position shift value (approximately
USD7 billion) is the largest weekly shift seen since June 11, 2013. In terms of the number of contracts, the net
number of shorts was -137,974 contracts on June 9 but plunged to -89,357 contracts on June 16. These
movements are bringing EUR exchange rates in line with EUR’s fundamental robustness. (At the time this report
was written, the latest available information indicated that the EUR short position as of June 23 was USD13.86
billion. That was up from the June 16 level, but the margin of increase was small.)
Rolling back of speculation recognized by ECB
The account of the April 15-16 ECB Governing Council monetary policy meeting noted that USD/EUR surged
from 1.06 to 1.10 within a few hours on March 18, and the intraday move was approximately +4.4%, the second
largest intraday move since the creation of EUR. The largest intraday move in USD/EUR was on September 22,
2000, and given that the ECB intervened in the FX market that day, the March 18 move can be considered the
largest intraday move unassociated with market intervention. Regarding the reason for that surge, the account
points out that – “the March move had been amplified by thin liquidity – as it occurred just after the close of the
New York session, when the market volume is usually at its lowest over the daily cycle – and by the unwinding of
very large non-commercial [this essentially means ‘speculative’] short euro positions.” I completely agree with this
analysis. Those who plan to continue selling EUR, a currency with considerably underlying strength, should be
sure to maintain awareness that EUR drops will be linked with subsequent surges of this kind. As explained
above, when a currency backed by huge current account surpluses and somewhat high real interest rates is
shorted by huge speculative forces, the basis for easily triggered upward rebounds has been emplaced. Recent
movements in EUR have demonstrated the reality of this situation.
Based on a recognition of this, it can be understood that, rather than being associated with expectations
regarding the Greece-Troika negotiations, it is more reasonable to consider EUR’s recent robustness to be the
result of increasing recognition of the precariousness of efforts to maintain accumulated EUR short positions in a
period when a major event is approaching. The trend countervailing the speculative shorting could be described
as “risk aversion-driven EUR buying.”
During the excessive JPY depreciation episode of the 2005-2007 period, some observers noted that there was a
risk of JPY appreciation owing to Japan’s current account surpluses and disinflationary tendencies (causing real
interest rates to be somewhat high). Few people were inclined to recognize the truth of that. In fact, the mood at
that time was one that made people tend to doubt the depth of knowledge and savvy of those who pointed out
that truth. It seems that the mood predominating in the EUR market during the past year has been very similar to
the mood during the excessive JPY depreciation episode.
Given the international economic climate, EUR selling involves a risk
Taking into account the international economic
climate, any unilateral trend of selling EUR and
buying USD would be difficult to form. Going by the
OECD’s Composite Leading Indicators, which
suggest an economic turning point in the next six to
nine months, the Euro zone and Japan are the two
zones that seem to be in a relatively advantageous
position for some time to come compared with the
rest of the world’s economies, with the U.S.
economy showing signs of entering a weak phase
(see chart). Naturally, in line with this, the GDP gap
is also assumed to shrink at its fastest pace, and
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precisely because of this, inflation will begin to strengthen, as the ECB itself also predicts. Mr. Draghi and the
accounts of the ECB Governing Council meeting strongly deny this, but against such economic/financial
conditions, speculation about whether the expanded asset purchase program (APP) can, indeed, be continued
until the end of September 2016 is bound to come up on a continuous basis in the markets. It cannot be denied
that this could directly result in an increase in EUR/USD. The abrupt interest rate changes in the European bond
markets since May are believed by many to be a side effect of the APP, and there is a possibility that EUR sale
triggered by monetary policy operations could become difficult going forward (moreover, it is difficult to know
whether the FRB’s normalization process will continue smoothly after the first rate hike has been implemented.)
A note of caution if EUR exceeds 1.15
Even if EUR strength is justified by an analysis of
the fundamentals, the problem is whether Europe
has the magnanimity to accept it. Having pushed
down EUR rates through a rapid-fire
implementation of monetary easing over the past
year, the ECB is unlikely to allow EUR levels to
return to a higher level all that easily. As
mentioned in the press conference of Mr. Draghi
on June 3, the ECB acknowledges that the
slowdown in external demand is directly linked to
the slowdown of the Euro zone economy (the
assessment of forecasts were downgraded in the
introductory statement, too), so the Bank’s
understanding seems to be that the benefits of a weaker domestic currency have not been as great as expected.
Under such circumstances, even if the 1.05-1.15 range that EUR has been in since late January is permitted,
once EUR exceeds 1.15, remarks aimed at containing the appreciation of EUR may emerge from member
states that do not take kindly to EUR appreciation. The chart shows the gap between the real effective forex rate
of each Euro zone country (the ECB calls these the Harmonized Competitiveness Indicators) against Germany.
Compared with the peak of the crisis, the disparity in competitiveness among the Euro member states has been
significantly narrowed, but France and Italy, which are always vocal whenever EUR strengthens, seem to have
preserved their high cost structures as they were (Spain, Portugal and Greece, meanwhile, have made
significant progress). As already mentioned, at the May 28-29 G7 meeting of finance ministers and central bank
governors (in Dresden, Germany), the fact that no joint statement recognizing the forex problem (specifically
USD appreciation) was issued could not be completely unrelated to the fact that half of the G7 members are
Euro member states, including France and Italy. In this regard, it will be extremely interesting to see how the G20
meeting of finance ministers and central bank governors (to be held in Ankara, Turkey) on September 4-5
assesses the USD appreciation/EUR depreciation (including the FOMC, which is expected to undertake an
interest rate hike about 10 days later). Given that the Euro zone economy is on the mend, its prices have
bottomed out, and the region has a high level of current account surplus, it will be difficult for it to justify the
depreciation of its domestic currency. It will be a matter of great interest to see how the U.S. will approach this
problem ahead of its first rate hike.
The Euro zone economy now and going forward – A false dawn?
Euro zone: Clear signs of consumption-led growth
QoQ）
Euro zone January-March GDP figures (2nd （％
Real GDP by each demand per sector (QoQ)
1.0
preliminary estimate) were announced in June, and
it has now become possible to confirm trends 0.5
regarding individual demand components (see 0.0
chart). Unchanged from the 1st preliminary estimate,
January-March real GDP was +0.4% qoq (+1.0% -0.5
yoy; figures below are qoq unless otherwise noted). -1.0
2012Q1
2012Q3
2013Q1
2013Q3
2014Q1
2014Q3
Examining individual demand components, it is
Inventory investment
Household consumption expenditure
noteworthy that 0.3 percentage point of the +0.4%
Government consumption
GDP rise was attributable to household
Gross fixed capital formation
Net export
consumption. Looking back at the Euro zone
Real GDP
economy since the January-March 2014 period, it is （Source）Eurostat
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clear that household consumption has been the principle growth driver. (Of the +1.30% growth realized from the
January-March 2014 period through the January-March 2015 period, +1.08 percentage points were contributed
by household consumption.) In addition to household consumption, there were contributions of +0.2 percentage
point from gross fixed capital formation, +0.1 percentage point from inventory investment, and +0.1 percentage
point from government consumption.
While it is encouraging that investment (gross fixed
capital formation) is playing a positive role in promoting
GDP growth, as explained below, since EUR
depreciation has showed no sign of promoting significant
export growth, sustained investment growth will have to
depend on robust internal demand. The unemployment
rate has gradually descended from historic record high
levels, and this trend has been accompanied since April
by strong figures for retail sales etc. within the area that
have rarely been seen in recent years, but the positive
nature of these figures must be discounted somewhat in
light of the fact that they are predicated on such
temporary tailwind factors as low oil prices, low interest
rates, and EUR depreciation.
ECB paper denies effect of currency depreciation
Exports made a +0.3 percentage point contribution to the January-March GDP, and imports made a -0.5
percentage point contribution, so the contribution of net exports was a -0.2 percentage point negative contribution.
Full-fledged EUR depreciation began from last May, and the contribution of net exports to the +1.1% growth
achieved by the Euro zone during the depreciation period from the second quarter of last year through the first
quarter of this year was a -0.2 percentage point negative contribution. One can choose to emphasize the positive
fact that the weakness of net exports was compensated for by the strength of internal demand, but it is
nonetheless disturbing to note that, despite close to 20% currency depreciation in one year, net exports made no
contribution to the Euro zone’s GDP growth.
There is some truth to the explanation presented by ECB President Draghi at the post-Governing Council press
conference in June, in the that the effect of currency depreciation was not generated owing to the somewhat
weak state of external demand. However, it is also debatable whether it was reasonable to have expectations
that currency depreciation would generate positive effects. In June, the ECB released a working paper entitled
“The exchange rate, asymmetric shocks and asymmetric distributions,” that argues based on its analysis that
“exports appear to be sensitive to appreciation episodes, but rather unaffected by depreciations.” Essentially, the
paper argues that companies find it difficult to reap benefits from boosting exports in response to currency
depreciation because of the cost and time required to expand capacity, but that companies facing currency
appreciation relatively quickly restrain their export volume because of the deterioration of their competitive
strength. In short, the analysis is denying much of the beneficial effects that many people attribute to currency
depreciation. While the argument of an ECB working paper cannot be considered to be the official view of the
ECB, the fact that currency depreciations do not seem to be producing the expected effects is something that
can be seen from GDP statistics.
So, even though the ECB comprehensive easing efforts beginning with negative interest rates and culminating in
the APP have generated a dramatic currency depreciation effect, in light of the working paper’s analysis, it is
reasonable to be dubious about the impact of those efforts on the real economy. On the other hand, the effects of
those efforts in terms of ultra-low interest rates and stock price increases have appeared in line with the ECB’s
plans, and the efforts’ effect in boosting inflation expectations has also been confirmed. The problem is that, going
forward, the process of shrinking the APP has a high likelihood of inducing a roll-back of the capital market effects
on forex rates, bonds, and stocks, and it is highly likely that companies’ negative reaction to the currency
appreciation generated during that process will be greater than their positive reaction to the preceding currency
depreciation. The central bank should naturally suffer losses on the bonds it has been purchasing. Even before
the exit strategy is implemented, given such factors as the rise in bond market volatility, there is plenty of leeway
for debate about whether the comprehensive easing should be considered a beneficial policy overall.
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Importance of identifying false dawns
Let’s return to the subject of GDP. Ultimately, if currency depreciation cannot be expected to have a large
beneficial effect on exports, then the sustainability of robust personal consumption will be the key focus of efforts
to forecast Euro zone GDP trends. In this regard, it is certainly rational to – as has the EC Spring Economic
Forecast – expect growth benefits from the tailwinds of EUR depreciation, low oil prices, and low interest rates.
However, EUR-denominated oil prices bottomed out in mid March, and the secondary effects of the APP are
causing sharp fluctuations in interest rates. As we begin to see signs of tailwinds becoming headwinds, it will be a
very interesting to see what kind of countering maneuvers the ECB will be able to muster up, given the general
perception that the ECB has already done its utmost and exhausted its policy options. In the experience of Japan,
when the central bank has already embarked on quantitative easing policies and yet the economy still has only
weakly sustainable recovery capabilities, there will be a number of “false dawns.” The argument that “the Euro
zone has already gotten over the hump in its Japanification process” is becoming increasingly persuasive, and
now is a time for maintaining a prudently cautious posture and refraining from too easily believing in
overoptimistic theories.
Daisuke Karakama
Chief Market Economist
Forex Division
Mizuho Bank, Ltd.
Tel: +81-3-3242-7065
[email protected]
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