Dollar-yen rally stalls: What next?

Shinzo Abe, Japan's prime minister.
Tomohiro Ohsumi | Bloomberg | Getty Images
Shinzo Abe, Japan's prime minister.

The Japanese yen left many currency experts wrong-footed on Monday with a seemingly unstoppable depreciation coming to an abrupt halt as the country received worse-than-expected growth data.

The dollar fell back from seven-year highs against the yen as Tokyo stock markets were sent tumbling. The greenback had seen an initial spike after the data release and moved close to 117 yen, but fell back to trade near 116 yen by 10 a.m. London time.

The shock growth data - which showed a contraction by an annualized 1.6 percent in the July-September quarter - was supposed to be a negative for the yen. The soft figures are likely postpone the implementation of another sales tax hike and could also force snap elections by the dovish Prime Minister Shinzo Abe, who would then gain a greater mandate to push through yet more stimulatory measures.

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"What happened?," Simon Derrick, the chief currency strategist at Bank of New York Mellon, said in a morning note when questioning the moves in the yen.

"The most likely explanation for today's move comes from the JGB (Japanese government bond) market where yields on the benchmark 10-year ended up, rather than down, on the day."

The sales tax hike in Japan is seen as a key reason behind the weakness in the growth numbers despite it also being a vital policy for the government to claw back its overstretched finances. The postponement - or even the cancellation - of a second phase could therefore be helping investors shy away from the government's debt markets, according to Derrick, which could have led investors to pile into cash.

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Kit Juckes, the global head of foreign exchange strategy at Societe Generale, adds that the yen was looking oversold. Despite the brief respite, Juckes believes that this is not the end of the yen's devaluation and is just a correction. Derrick also predicts that Monday's strength in the yen is unlikely to be sustained, adding that the Bank of Japan is unlikely to support any destabilizing factors in the Japanese government bond market.

There were numerous predictions last week of a serious depreciation for the currency in the coming months which has fallen by over 30 percent since the start of 2013 against the dollar. Bearish Societe Generale strategist Albert Edwards even called for a level of 145 for the end of March as the country's central bank positions itself for more bond-buying to combat decades of stagnation.

Like Derrick and Juckes, BNP Paribas strategists are also not expecting any prolonged change in the yen's trading patterns. In a note on Monday morning, they urged clients to "buy on dips" with regards to the dollar-yen rally. Barclays analysts agreed, suggesting that Abe will announce a delay to the sales hike on Tuesday and dissolve the lower house of parliament on Wednesday for an election on December 14.

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Abe said on Monday that he would analyze the situation calmly and decide whether to go ahead with a planned sales tax hike.

"We expect the JPY to be under pressure. Our technical strategist looks for the next level of resistance for USDJPY at 117.00 and then 117.95," the investment bank said in its note.