Euro’s Loss Being Yen’s Gain May Be Headache for BOJ: Analysis

Haruhiko Kuroda, governor of the Bank of Japan

Brent Lewin/Bloomberg

The Bank of Japan will largely be a bystander this week while the market focuses on the European Central Bank meeting, congressional testimony by U.S. Federal Reserve Chair Janet Yellen and the U.S. jobs report. But further aggressive easing by the ECB may have an undesired effect on the Japanese yen’s trade weighted index (TWI), Bloomberg strategists Richard Jones and Vassilis Karamanis write.

The Japanese currency has been appreciating on a trade weighted basis in large part due to the euro’s weakness against the yen, having lost 12.5 percent from its high last December and 7.1 percent from the 2015 high in June.

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The focus on the yen’s value against the U.S. dollar as a barometer of yen strength/weakness may overlook the currency’s relative performance against other major trading partners, most notably the euro area. Japan is the fourth largest export economy worldwide, and a weaker euro due to an expansion of stimulus by the ECB can only hurt its competitiveness.

The Deutsche Bank’s yen TWI, in which the dollar has a weighting of 46 percent and the euro 39 percent, shows that the JPY TWI has recently strengthened: it has risen 5.9 percent from a low seen in December last year, and is up 4.5 percent from 2015 low in June.

By contrast, Deutsche Bank's euro TWI is 11.7 percent weaker than in December 2014, and 5.4 percent lower than the 2015 peak seen in August. The two biggest contributors to the euro TWI are the dollar (34 percent) and the pound (31 percent), both of which have appreciated considerably against the euro: the dollar has gained 18 percent from December 2014, and the pound 13.1 percent over the same time period.

The euro’s 12.5 percent fall against the yen over the past year or so has also helped push down the euro TWI, although this pair is less important for the ECB than it is for Bank of Japan, as the yen accounts for only 14 percent of the euro TWI.

The spread between the euro and yen TWIs has kept narrowing since early June, trading near the 7-month low seen on Nov. 30.

Technically, the euro is currently testing strong support at 130 yen. The pair may from here be set to test 133.53, the 55 daily moving average, amid a few bullish signs. Yet, a daily close below the 129.63 Fibonnaci level might signal additional yen strength all way to 126.10 against the euro.

Additionally, yen upside demand against the euro and the pound by interbank and leveraged names, cited by two traders in London, may also contribute to currency’s strength on a trade weighted basis. Going long yen against the pound and the Swiss franc are among Morgan Stanley’s top trades for 2016.

Note: Richard Jones and Vassilis Karamanis are FX & Rates strategists who write for Bloomberg. The observations they make are their own and are not intended as investment advice.


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