Whither EUR/JPY

January 17, 2013

A new leadership team in Japan has used blunt, albeit not always consistent, language to signal a desire for the yen to depreciate.  Although governments don’t always get what they want from currency markets, it is as a general matter easier to promote currency weakness than strength.  Moreover, the new policymakers inherited a yen that was historically elevated, and they have achieved initial success.  Demonstrated results can encourage speculative trading and thus become self-perpetuating. 

Many investors prefer to short the yen against the euro rather than speculate directly in dollar/yen.  Since a common European currency was created at the start of 1999, the width of the high-low range of EUR/JPY, some 91%, has exceeded that of dollar/yen, which is 77.5% wide.  The extremes of the euro – yen relationships during the past five years were recorded almost exactly four years apart.  The yen’s low of 170.0 per euro, an all-time record, was stamped on July 23, 2008, while its high of 94.075  on July 24, 2012, was still 5.4% shy of the post-1998 peak.  Over the four-year span, the yen appreciated 80.7% against the common European currency versus a 38.3% concurrent advance against the dollar. 

Monetary analysis also favors taking a position in EUR/JPY rather than USD/JPY.  Future monetary policy stances between the Bank of Japan and the European Central Bank are likely to stand in starker contrast to one another than the BOJ and Fed stances.  All three central banks will be running accommodative policies because of large shortfalls in actual GDP from potential GDP.  However, inflation in the United States and Japan are each lower than target, whereas inflation in the euro area lies above target and has been so since November 2010.  Both the Fed and Bank of Japan have expressed a desire for future inflation to be higher than they expect such to be on unchanged policy and are taking action to nudge inflation higher.  At the ECB, however, officials acknowledge that inflation is creeping lower and fully expect such over the course of 2013 to move into target, that is below but close to 2.0%.  Revised forecasts released last month postulated CPI ranges centered on 1.6% this year and 1.4% in 2014.

The yen’s 21.8% depreciation from 94.075 per euro last July to 120.35 per euro earlier today represents a 34.6% reversal of the aforementioned four-year-long uptrend.  At 123.1 per euro, a Fibonacci 38.2% correction will have been secured, so that level represents a near-term objective for some.  Somewhat beyond that milestone lies 126.4 per euro, which is the average value of the relationship over the entire 14-plus lifetime of the EUR/JPY relationship.  Think of 126-127 as the pair’s center of gravity, and it also seems reasonably attainable over time.

Significant euro gains beyond $1.40 and 130 yen are a chancier proposition, given the region’s debt problems and poor potential for generating growth.  New growth projections released by the World Bank anticipate real GDP in Euroland expanding on average by just 0.7% per annum over the three years 2013-2015.  That’s just a shade better than a fourth of the projected 2.6% per annum U.S. expansion rate, and it is half a percentage point a year less than what the World Bank expects from Japan.  It’s not surprising to see the U.S. economy expanding faster than either Japan or the euro area because of America’s better demographics and superior productivity performance.  U.S. GDP from 1999 to 2012, for instance, climbed 2.2% a year, easily beating the other two regions.  What is noteworthy is that growth in the euro area of 1.5% per annum was two-thirds faster than Japan’s 14-year 0.9% pace. 

Assuming the World Bank projections have the ordinal ranking of future growth more or less correct, Japan and Euroland will be trading places in the hierarchy.  The outgoing EU President Jean-Claude Juncker has already complained that euro appreciation over the past half year or so could exert undue drag on the fragile and trade-dependent Ezone economy.  ECB officials generally protest currency values much more seldom than their Japanese counterparts, but it happens.  When in 2008 former ECB President Trichet called the $1.55-$1.60 euro range “brutal,”  his characterization was a catalyst behind a trend reversal in the exchange rate.  Indeed, one of the difficulties in handicapping the prospects for major currencies this year in these early days of January is the risk of intensifying currency wars.  Compared to markets that march to the beat of economic forces without government interference, it’s harder to predict outcomes when headlines have to be factored in proclaiming what this or that official just said about foreign exchange values.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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