2012 Forecast: USDJPY To Move Sideways

We expect the movement of Japanese yen this year will be directed by factors including BOJ’s intervention, risk appetite and Fed’s QE3. Optimism of FOMC policymakers and the fiscal situation in the US will exert downward pressure on USD/JPY in the first half of the year but the BOJ will likely defend the level of 75 via intervention. Upside of the currency pair will also be capped by sluggish US economic growth and probable implementation of Fed’s QE3 later in the year. In this case, USD/JPY will likely be range-bounded this year.

Japan's GDP grew +1.4% in 3Q11, signaling a strong improvement after the earthquake in March. Yet, the main contributors to growth were exports and private spending while government spending was small and capital spending by businesses even shrank. The outlook in the world’s third largest economy remains risky in 2012. Deflation persists in Japan. Headline CPI contracted -0.5% y/y in November, accelerated from a month ago. Core CPI excluding fresh food and energy slid -1.1% y/y in November, following contractions of -1.0% and -0.4% in October and September respectively. Pessimistic consumers, sluggish job market and declining commodity prices are expected to keep inflation low this year.

The BoJ retained the loose monetary stance. In December, policymakers voted unanimously to keep the uncollateralized overnight call rate at 0-0.1%. The central bank had expanded in October its asset purchases program by 5 trillion yen to 20 trillion yen for purchases of JGBs, Together with the 35 trillion yen for purchase of fixed-rate operations, the program is expanded to 55 trillion yen. The BoJ will likely remain accommodative in monetary policy this year.

On the fiscal front, the Japanese government will probably be one of the very few governments that adopt fiscal expansion this year. in order to boost growth and reconstruction after the earthquake, a supplementary budget of 4 trillion yen has been approved and further measures will likely be introduced.

Although the Japanese government sold at least 14.3 trillion yen last year to curb against yen’s appreciation, the currency was still one of the best performing currency due to risk aversion. Great uncertainty over the outlook of the US and Eurozone, in particular, also reduced Japanese investors’ desire to hold foreign assets. The situation will continue in 2012, at least in the first half of the year.

The sovereign debt crisis in the Eurozone will remain a key issue this year and will affect market sentiment. Risk-averse investors will likely flee to Japanese yen as a safe haven. Although recent economic data in the US has improved, high unemployment rate and the fragile growth outlook suggest that QE3 is likely. Together with fiscal consolidation, US yields may be weighed down, and hence USDJPY. While Japan pledged to intervene on the yen whenever necessary, its commitment would not be strong unless USDJPY falls to as low as 75. That’s why we set our 2012 low of USDJPY as that level.