Forex Medium-Term Outlook - Mizuho Bank · Forex Medium-Term Outlook 31 July 2014 ... Forex rates continued to be stable during July, and yet ... “Fiscal 2013 questionnaire-based

Forex Medium-Term Outlook

31 July 2014

Mizuho Bank, Ltd. Forex Division

Medium-term Forex Outlook Mizuho Bank Ltd. 1

【Contents】 Overview of outlook ・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・P. 2

USD/JPY outlook – Time to reconsider weak JPY Assessing the current value of JPY –Has the weakening of JPY reached the break-even point? P. 3 Nikkei average index & USD/JPY rate –Overheating seen in USD-denominated Nikkei average index・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・ P. 6 Japan’s monetary policies now and going forward – 1% remark likely to invite controversy・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・P. 7 U.S. monetary policies now and going forward – Present rate hikes in preparation for future rate cuts? ・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・P. 9 Lessons from history – Waiting for selling JPY by Japanese – Is this the sixth time? ・・・・・P. 10 “Accidental Events” Present Opportunities for Buying on the Dips – Skillfully Coping with Narrow-Range Forex Rate Movemen・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・P. 12 USD/JPY outlook – Situation continues to favor buying on the dips ・・・・・・・・・・・・・P. 13

EUR Outlook – How to interpret the Europe-U.S. commodity price gap ECB Monetary Policies Now and Going Forward: Remembering the BOJ’s struggle・・・・・ P. 15 EUR faces outlook of a commodity price gap – Increasingly clear perception of a EUR zone lag・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・・P. 17


Overview of outlook Regarding USD/JPY, reasons to purchase JPY remain scarce from the supply-demand (external account) and interest rate (monetary policy) perspectives, and our basic understanding that “leaving the situation as is will lead to JPY weakness” remains unchanged. Japan’s trade deficit for the first half of 2014 amounted to JPY7.6 trillion, a new record and, if the current deficit pace is sustained, there is a possibility that the deficit for the entirety of 2014 will surpass the JPY15 trillion landmark. Given the clear difference between the monetary policies of Japan and the U.S., there is a strong perception that JPY selling is a safe bet, and the prospect of the normalization of FRB policies makes it likely that USD will continue appreciating against JPY. In the current situation, when it is assumed rather than merely expected that JPY will show additional depreciation, Japan should be considering the possibility that it has already reached the break-even point regarding the costs and benefits of JPY depreciation at the current level of depreciation. This article has stubbornly and repeatedly made the point that, during the forecast period, USD/JPY market participants should be seeking to take advantage of opportunities to buy on the dips associated with “accidental events”, and there were many such opportunities in July owing to the frequent occurrence of events that generated geopolitical risks. Given the expectation that there will be no major change in the monetary policies of Japan or the U.S. at least through this autumn, it seems prudent to anticipate that 2014 will set a new record for the small range of USD/JPY rate fluctuation, surpassing the previous record set in 2011. (It will still be a new record small fluctuation margin even if USD/JPY rises to JPY110.) On the other hand, EUR further depreciated during July, and it is undeniable that the background factors causing this included a rise in Russia-related geopolitical risks owing to such situations as the downing of a Malaysian Airlines plane. Assuming that these events will have long-term ramifications in the form of various sanctions restricting economic relations with Russia, it is inevitable that EUR will have a heavy upside potential. However, pressures on EUR stemming from such factors as accumulating current account surpluses and persistent disinflationary tendencies remain strong, and it appears that only a “USD buying in response to FRB policy normalization” scenario would be capable of overcoming the impact of this “structural EUR buying” pressure. Essentially, it appears that overcoming the pressure would require improvement in the expected rate of returns on USD-denominated assets. To preclude misunderstanding, it is worth emphatically repeating that when internal-external interest-rate gaps can only induce currency depreciation by means of spurring external securities investments – this is a symptom of the “JPY-ization of EUR” scenario. The JPY-ization concept is not limited to its “disinflation = currency appreciation” aspect but also encompasses a pattern of replicating JPY’s past behavior both when strengthening and weakening. However, since a sharp rise in U.S. interest rates seems unlikely at least during 2014, it seems unlikely that EUR will show a trend of sustained weakening against USD. Summary table of forecasts

USD/JPY 100.76 ～ 105.45 99 ～ 105 101 ～ 108 101 ～ 110 102 ～ 111 102 ～ 112

EUR/USD 1.3366 ～ 1.3995 1.32 ～ 1.37 1.33 ～ 1.38 1.34 ～ 1.40 1.35 ～ 1.41 1.36 ～ 1.42

EUR/JPY 136.25 ～ 145.08 134 ～ 140 136 ～ 143 137 ～ 145 139 ～ 147 142 ～ 150

2014 Jan-Jul 2014 2014 2015 2015 2015

(108)

(Actual) Aug-Sep Oct-Dec Jan-Mar Apr-Jun Jul-Sep

(102.80) (103) (104) (106) (107)

(149)

(1.3398) (1.34) (1.35) (1.36) (1.36) (1.38)

(137.74) (138) (140) (144) (146)(Notes) 1. Actual results were released on 31 July 2014 around 10am TKY time. 2. Forecast rates are quarter-end level Exchange rate trends & forecasts

70

80

90

100

110

120

130

06/1Q 07/1Q 08/1Q 09/1Q 10/1Q 11/1Q 12/1Q 13/1Q 14/1Q 15/1Q

USD/JPY


1.1

1.2

1.3

1.4

1.5

1.6

1.7

06/1Q 07/1Q 08/1Q 09/1Q 10/1Q 11/1Q 12/1Q 13/1Q 14/1Q 15/1Q

EUR/USD

85

95

105

115

125

135

145

155

165

175

06/1Q 07/1Q 08/1Q 09/1Q 10/1Q 11/1Q 12/1Q 13/1Q 14/1Q 15/1Q

EUR/JPY

USD/JPY outlook – Time to reconsider weak JPY Assessing the current value of JPY –Has the weakening of JPY reached the break-even point? Has the weakening of JPY reached the break-even point? Forex rates continued to be stable during July, and yet the narrow range of rate fluctuations is in line with companies’ expectations since the start of 2014. (Conducted in January 2014, the Cabinet Office’s “Fiscal 2013 questionnaire-based Survey of Corporate Behavior” asked respondents about their expectations regarding USD/JPY in January 2015, and the response was JPY105.70 – roughly the same as the exchange rate at that time.) The survey found that the USD/JPY level at which exporters could operate profitably was JPY92.20, and this suggests that the exporters are able to earn considerable forex gains at the current USD/JPY level. However, it is also true that the some portions of the July 7 edition of the BOJ’s Regional Economic Report (Sakura Report) suggests that the current level of JPY depreciation may correspond to the break-even point. For example, BOJ Nagoya branch head Toru Umemori reported at a meeting of BOJ branch managers on how companies in his region (the Tokai region) were coping with the current forex rates, saying that, although there was some differences in different industries, the companies were generally comfortable with the current forex rates regarding raw material and product prices and were not hoping for the further weakening of JPY. It is highly interesting to hear this about Tokai region companies, which center on automobile makers that are believed to be receiving the greatest amount of benefits from JPY depreciation. The Sakura Report also includes such JPY-depreciation-related comments as the following: (Limits of cost-rise-absorbance capabilities) Even those supermarkets, hotels, and other businesses that have

through their own efforts been able to absorb the weak-JPY-induced rises in such input costs as electric power and foodstuffs will have difficulty in absorbing additional input-cost increases and are therefore implementing product/service price increases synchronized with the consumption tax rate hike (Niigata, Nagoya, Oita, Saitama head office)

Reference points of USD/JPY rate in 2014Break-even rate for Japanese companies as of FEB 2014 92.20

Purchasing power parity（Corporate goods prices, 1973 base, APR 2014）

98.56

Corporate planning rate（BOJ Tankan, JUN 2014 survey, FY2014）

100.20

Lowest rate in 2014 100.76

Average rate in 2014 102.50

Highest rate in 2014 (2 JAN 2014) 105.45

Forecast rate by Japanese companies as of JAN 2015 105.70（Source）Cabinet Office, Government of Japan, Bloomberg, Datastream


Already reflected in a CPI uptick, the weak-JPY-induced rise in mineral fuel import prices has placed upward pressure on the prices of a wide variety of goods. Since disrupting price-competition-style corporate behavior predicated on price decreases is one of the aims of quantitative and qualitative monetary easing (QQE) policies, the policies can thus in a sense be said to be generating the “desired effect” (the phrase used in BOJ announcements). As is reflected in the subtitle “Limits of cost-rise-absorbance capabilities,” however, though the weakening of JPY has a price effect that is boosting overseas profits, it is having an even greater effect in boosting corporate costs, and this is the situation that has led to talk of surpassing the break-even point. Corporate performance statistics are showing a rise in ordinary incomes considerably greater than growth in operating incomes (see chart), and this primarily reflects exchange gains within non-operating profit. This is not in of itself a bad thing, but judging from the abovementioned comments of the BOJ Nagoya branch head Umemori and the comments in the Sakura Report, the further weakening of JPY will cause some companies to cross their break-even points and may raise the possibility that even growth in ordinary income will not be feasible. Of course, the desired form is one that the weakening of JPY boosts export volume, propels a virtuous cycle of “production growth → income growth → consumption growth,” and drives dynamic expansion of operating income stemming directly from business operations. As is well known, however, there are no longer great expectations regarding the “weakening of JPY → production growth” mechanism, and it seems that voices expressing expectations regarding the generation of a J-curve effect have become much quieter than previously. The pattern of ordinary profits greatly exceeding operating profits was also seen during the economic recovery period referred to as the “weak-JPY bubble” (January 2002 – February 2008) and, given that that period was widely characterized as one of “imperceptible economic recovery” the current repetition of the pattern is not auspicious. Export-boosting effect of foreign direct investment also weakening In its Outlook of Economic Activity and Prices (Outlook Report) published in April, the BOJ pointed out “firms' stance of placing priority on domestic shipments in response to the front-loaded increase in demand,” “sluggishness in emerging economies including ASEAN economies that have strong ties with Japan's economy,” and “structural factors such as a spreading of the shift of Japanese manufacturers' production sites to overseas” as some of the factors delaying Japan’s export recovery. However, now in July, it is natural to see the noise from the reactionary increases/decreases related to the consumption tax rate hike as having faded away, and so the reasoning that “exports were unable to grow because domestic shipments were being prioritized” is now a bit hard to accept. Rather, one must look directly to structural factors such as the expansion of Japanese manufacturing companies’ foreign production bases. Such trends can also be confirmed by looking at the various economic indicators. For example, Japanese export companies promoted the relocation of their production bases through foreign direct investment (FDI) because, in addition to the major underlying assumption that the Japanese markets will shrink as a result of the ageing of society and low birth rates, there was also the chronic strengthening of JPY. In the early stages, such a move could be expected to boost domestic exports as the materials necessary for production in foreign locales were exported from Japan. However, as the exhibit shows, the ratio of imports from Japan in the total procurements of the overseas subsidiaries of Japanese companies (especially manufacturing sector) have been steadily decreasing. In other words, it appears that the export-boosting effect of FDI is in the process of weakening, and one cannot but think that changes are taking place in a direction not conducive to an increase in exports from Japan.

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

80 83 86 89 92 95 98 01 04 07 10 13

（％）

（Source）Ministry of Finance, Japan(Note) Quartly average

Transition of ratio of profit on sales（all size・all industry base）

Ratio of operating profit on sales

Ratio of ordinary profit on sales

20%

25%

30%

35%

40%

45%

50%

Year 2001 Year 2003 Year 2005 Year 2007 Year 2009 Year 2011

（Source）Ministry of Economy, Trade and Industry

Transition of import ratio from Japan by overseas subsidiaries

Japanese companies in total ManufacturingTransportation equipment General machineryElectric machinery


Travel balance benefits from JPY weakness Meanwhile, the Sakura Report contained the following favorable comments regarding JPY weakness: [Department stores, etc.] The increase in foreign visitors to Japan as JPY weakens has been propping up

sales, keeping the reactionary decrease in sales within assumed levels (Sapporo, Nagoya, Kyoto, Fukuoka). [Hotel] The increase in foreign tourists amid JPY weakening is contributing to an increase in occupancy ratio

of accommodation facilities (Sapporo, Niigata, Kyoto, Osaka, Kobe). There are also indicators that back such assessments – the travel balance turned black for the first time in 44 years this April. Considering that the travel balance posted an average monthly deficit of -JPY 230 billion during 2000-2005, one cannot ignore the recent change in this trend: The average monthly deficit has shrunk to -JPY 38 billion in the past one year (May 2013 to May 2014), and reached a level in recent months that allows for consistent surpluses (see chart). Having said that, the level of the travel balance by itself, is only within the “margin of error” of the increase in imports resulting from JPY weakness. This makes it rather insignificant in light of the major argument presented above, that the “further weakening of JPY will cause some companies to cross their break-even points.” Abenomics has given us a chance to rethink the benefits of JPY weakness “No one wishes to see JPY weaken further.” This was a comment that came out of Nagoya, the nucleus of Japan’s car industry, the main industry propping up our exports. It is a comment that gives us the opportunity to consider afresh whether JPY weakness is really a desirable thing. Also, last April, (then) Chairman Yonekura of the Nippon Keidanren said regarding USD/JPY, which was stalling in the vicinity of JPY 100, that “One gets the feeling that this is the limit,” “(a further weakening of JPY) would make FDI difficult except in growth areas,” (Reuters, April 22, 2013). In its long history, rarely has a chairman of the Keidanren made remarks intended to deter the further weakening of JPY. Until the time the Liberal Democratic Party held up a policy of strong reflation in November 2012, the “cost of JPY weakness” was not something that was even brought to the debating table. Considering that, we should take the present opportunity to debate the costs of a weak JPY as a forward-looking sign that Japan is entering a new phase. Abenomics has presented us with an opportunity to rethink the benefits of JPY weakness, which had so far been unconditionally taken for granted as a desirable thing, and in this sense, it can be said to have had some benefit. Will Japan’s trade deficit surpass the JPY15 trillion level? – Deficit growth pace entering the danger zone Japan’s trade balance situation could also have a similar significance as the opportunity to rethink the merits of JPY weakness The trade figures released by the Ministry of Finance in July indicate that Japan recorded a JPY822.2 billion trade deficit in June, exceeding market expectations (JPY642.9 billion) and extending the run of trade deficits to 24 consecutive months. Exports were down 2.0% yoy to JPY5.9396 trillion (the 2nd consecutive month of decrease), and imports were up 8.4% yoy to JPY6.7619 billion (the first increase in two months) – it seems that a stable pattern of export shrinkage and import expansion has been established. As a result, the country’s trade deficit for the first half of 2014 amounted to JPY7.5984 trillion, a new record. If the current deficit pace is sustained, there is a possibility that Japan’s deficit for the entirety of 2014 will surpass the JPY15 trillion landmark (see chart). Given that Japan’s income account surplus over the past three years was approximately JPY15-17 trillion, the pace of trade deficit growth appears to be pushing the country into a danger zone, insofar as it could cause the current account balance for the entirety of 2014 to become a deficit.

-400

-350

-300

-250

-200

-150

-100

-50

0

50

96/01 97/12 99/11 01/10 03/09 05/08 07/07 09/06 11/05 13/04

(Bil. yen）

（Source）Ministry of Finance, Japan

Transition of overseas travel balance

-4.8

-7.6

-11.5

-15.2-16

-14

-12

-10

-8

-6

-4

-2

0JAN-JUN 2013 JAN-JUN 2014 2013 annualized 2014 annualized

（Tril. yen）

（Source）Datastream (Note) 2014 annualized: assumption

Japan's trade balance


Analysis of trade balance factors: Settling the debate about the effect of weak JPY After analyzing changes in Japan’s trade balance since 2013 from three perspectives – volume, prices, and forex rates (see chart on the next page) – it becomes apparent that the more the weakening of JPY proceeds, the more trade deficit increases with the forex rate factor as a principal driver. It is also worth noting that the volume factor is making a particularly large contribution to the trade deficit. This contrasts sharply with the “weak JPY bubble” period of 2005-2007, when the forex factor and the volume factor propelled trade surplus expansion. Several facts come into focus from an examination of the current change (deterioration) in Japan’s trade balance. For example, it appears that (1) the weakening of JPY is not promoting large growth in export volume, but on the other hand (2) import volume is increasing, reflecting the expansion of domestic demand, and (3) export prices appear less sensitive to the impact of the weakening of JPY than import prices. Regarding the overall trade balance, if one calculates yoy changes since 2013 on a quarterly basis, there has not been a single movement toward a surplus, and it is clear that the steady trend of growing deficit margins is a reality (see portion of graph within dotted lines). Given this situation, it may be time to consider the “does the weakening of JPY have a positive effect on the real economy or not” debate to be conclusively settled. Nikkei average index & USD/JPY rate –Overheating seen in USD-denominated Nikkei average index USD-denominated Nikkei average index keeps above USD150 for a month Since middle of April this year, volatility is declining mainly in the USD/JPY market as well as in financial markets generally, but the robustness of stock prices is noteworthy amid those markets. Yesterday’s Nikkei average index closing price was JPY15,618.7, protracting the first period of levels above the JPY15,600 seen in a half year, but it is impossible to deny that this is suggestive of over-exuberance, even though it reflects the impact of the rise of USD/JPY to levels in the vicinity of JPY102. When evaluating and projecting Nikkei average levels, this article has focused on foreign investors’ high-level presence in Japanese stocks and the significance of USD-denominated prices. In this context, this article has repeatedly noted that, since the previous economic recovery period (January 2002 – February 2008), USD150 has been a landmark level. When the Nikkei average rose to approach JPY18,300 in February 2007, it is noteworthy that the USD-denominated level rose to roughly USD154 before the uptrend was reversed. This pattern is also seen in the stock price surges last May and early this year – both surges brought the USD-denominated level up close to USD154 before a downtrend commenced. (In view of this, it might be reasonable to more-precisely define the landmark level as USD154, but this article will focus on the round figure of USD150.) While movements in USD/JPY have almost disappeared since the start of July, the Nikkei average index has continued showing uptrends in JPY terms and, accordingly, the USD-denominated level reached USD153 yesterday. The USD-denominated level has continued fluctuating at levels above USD150 almost every day in July, and this appears to be the longest bout of persistently high USD-denominated Nikkei average levels since Abenomics became a hot topic of discussion.

60

70

80

90

100

110

120-8

-6

-4

-2

0

2

4

6

2004 Q1

2004 Q4

2005 Q3

2006 Q2

2007 Q1

2007 Q4

2008 Q3

2009 Q2

2010 Q1

2010 Q4

2011 Q3

2012 Q2

2013 Q1

2013 Q4

（Year 2010 average=100）

（Tril. yen）

（Source）Bank of Japan, INDB

Perspectives of trade balance (YoY changes)

FX factorVolume factorPrice factorAmountNominal effective yen rate（right axis, reversed scale）

Weak yen↑↓

Strong yen

50

70

90

110

130

150

170

190

210

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

22,000

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

（USD）（JPY）

（Source）Bloomberg (Note) USDJPY: closing rate at 5pm NY time

Transition of nikkei average index（JPY vs. USD）

JPY USD 150 dollar


It is worth watching out for the possibility that foreign investors will consider these price levels to be suggestive of considerable overheating of Nikkei average index. While foreign investors’ moves to considerably increase the share of Japanese stocks in their portfolios have been characterized as a positive trend in announcements by the Japanese government and the BOJ, there is no such trend of increase in the share of Japanese stocks in foreign investors’ portfolios at this time. Going forward, it seems that there will have to be an adjustment – either (1) a sharp rise in USD/JPY or (2) a drop in the JPY-denominated Nikkei average index. Currently, given the continued robustness of U.S. economic indicators and numerous associated situations supporting USD buying scenarios, it appears that there is a possibility of the (1) scenario, but past experience indicates that the likelihood of the (2) scenario is quite high. Nikkei average index becoming increasingly independent of forex rates The key problem (discussed repeatedly in previous editions of this article1) is that it is impossible to know whether the inverse relationships of “weak JPY & strong stock prices” (“strong JPY & weak stock prices”) seen so far will continue to be stable. In the case of the (2) scenario of a drop in the JPY-denominated Nikkei average index, the drop is likely to be accompanied to a certain extent by the unwinding of JPY selling positions built up in conjunction with stock investments, and an adjustment in the direction of strong JPY may occur. However, there is no guarantee that the strengthening of JPY will proceed to the same extent as stock depreciation, and there is a possibility that JPY selling against the backdrop of the demand-supply environment will continue to some extent. As can be seen from the chart, there is currently a clear divergence between trends in USD/JPY and in the Nikkei average index and, even if a stock price adjustment occurs going forward, there are differing views regarding the extent to which USD/JPY trends will change in line with the adjustment. My view is that, even in the case of a major (approximately 10%) stock price adjustment (to below the JPY14,000 level), USD/JPY may be able to sustain a level at least roughly in the JPY99-100 range. Japan’s monetary policies now and going forward – 1% remark likely to invite controversy Forecasts revised in the direction of stagflation At the BOJ Monetary Policy Meeting held on July 15, the status quo was retained. An interim evaluation of the April Outlook Report was also made at this meeting, but here again, there were no major changes. At the press conference following the meeting too, the fact that everything was going “on track” was emphasized, giving the markets nothing to get excited about. No change is apparent from the hitherto stance that, “although the policy is having the desired effect, the momentum required to achieve a stable 2% price stability is lacking, and if the growth in prices slows down, an additional monetary easing is conceivable.” The majority of policy board members’ forecasts (median value, see exhibit) related to Real Gross Domestic Product (GDP) indicated a 1.0% growth for FY2014 (a slight downward revision compared with the April forecast of 1.1%), while forecasts for FY2015 and FY2016 remained unchanged at 1.5% and 1.3%, respectively. The Core CPI (CPI excluding fresh foods) forecasts were kept unchanged at a 1.3% increase for FY2014, a 1.9% increase for FY2015, and a 2.1% increase for FY2016 (all figures exclude the impact of the increase in consumption tax rate).

1 Please refer to such previous editions of this article as the February 5, 2014 edition, entitled “The root causes of JPY weakness and share-price strength are different – A look at the recent trends in the forex and share markets.”

86

91

96

101

106

111

10,000

11,000

12,000

13,000

14,000

15,000

16,000

17,000

2013/01 2013/04 2013/07 2013/10 2014/01 2014/04 2014/07

（JPY）（JPY）

（Source）Bloomberg

Transition of nikkei average index & USDJPY rate

Nikkei average indexUSDJPY rate（right axis）

Outlook by policy board members of the Bank of Japan (y/y, %)

0.6～1.3 3.2～3.5 1.2～1.5<1.0> <3.3> <1.3>

0.8～1.3 3.0～3.5 1.0～1.5<1.1> <3.3> <1.3>

1.2～1.6 1.9～2.8 1.2～2.11.5 2.6 1.9

1.2～1.5 1.9～2.8 1.2～2.1<1.5> <2.6> <1.9>

1.0～1.5 2.0～3.0 1.3～2.3<1.3> <2.8> <2.1>

1.0～1.5 2.0～3.0 1.3～2.3<1.3> <2.8> <2.1>

（Source）Bank of Japan Note: ＜＞ is median estimate by policy board members

Case if remove the impactafter consumption tax hike

FY 2014

FY2015

Outlook as of APR

Real GDPCPI

（ex fresh food）

Outlook as of APR

FY2016

Outlook as of APR


However, focusing on the lower bound of the forecast range for FY2014, it is evident that, while the GDP growth rate forecast has been lowered, the forecast for prices has been raised. Also, looking at all the policy board members’ forecasts (as opposed to a majority of members’ forecasts), the growth rate forecast has been lowered not just for FY2014 but also FY2015 and FY2016, while the price forecasts have been raised. The revision, which involves “lowered growth rate forecasts and stubbornly high price forecasts,” is in the direction of stagflation2 – admittedly, this is a harsh view. The price “hedging period” nears expiry date As for prices, problematic aspects of it will come to the fore in the coming days. The phrase “for some time” in the statement that “the year-on-year rate of increase in the CPI is likely to be around 1¼ percent for some time,” which drew attention in the January Interim Evaluation of the Outlook Report, has remained unchanged for the past six months. At that time, BOJ Governor Haruhiko Kuroda said that “one could safely take (“for some time”) to mean around six months.” If one takes his explanation at face value, then it would seem that the “hedging period” is approaching its expiry date. Meanwhile, the April Outlook Report, which was the target for the recent interim assessment, stated regarding Core CPI that it was expected to “follow a rising trend again from the second half of this fiscal year,” so the basic scenario anticipates another rise in prices starting this autumn. In other words, there is currently some confusion whether to think that “prices will grow by around 1¼ percent until around January next year, which is half a year from now,” or whether they will “surpass the 1¼ percent growth level and start increasing again around autumn (September/October?) this year, which is the second half of the fiscal year,” so it is inevitable that this portion will be revised sometime in the not-distant future. It will be important to watch out for the possibility that such a revision could become entangled with expectations of an additional monetary easing. 1% remark likely to invite controversy Another point that drew attention was Mr. Kuroda’s remark that “there is no likelihood of the growth rate falling below 1%.” As the governor himself has categorically declared that there is “no (= zero) likelihood,” the markets are bound to see the 1% mark as the “line of defense.” If there comes a time when the CPI Core growth rate (excluding the impact of the consumption tax rate hike) either falls below or seems likely to fall below the 1% mark, expectations of an additional monetary easing will inevitably arise. Essentially, both the Outlook Report interim assessment and the Sakura Report see the reactionary decrease following the accelerated demand ahead of the consumption tax rate hike as smaller than originally assumed, but in terms of the actual experience of the man on the street, the common view seems to be that prices have increased more than the 3 pp rise attributed to the consumption tax rate hike, while real wages remain at the rock-bottom levels they have sunk to. In fact, the Sakura Report did mention the likely deterioration in consumer confidence amid declining real wages, and the possibility of this being reflected in consumption trends with a time lag. In terms of economic indicators, the slump in the May Machinery Orders (-19.5% mom), released on July 10, was received with considerable surprise. It makes one wonder whether it is safe to declare at this point that the consumption tax rate hike has had only a slight impact. It must be noted that, going forward, if the CPI Core growth posts a reactionary decline reflecting supply and demand, the recent 1% remark by Mr. Kuroda could result in market conditions that prompt a policy response (however, the BOJ’s forecast accuracy when it comes to predicting prices has been quite high recently, as also during the past one year or so, and it is quite possible that the governor only made such a declaration because he had some kind of credible assurance.) In anticipation of the approaching expansion of the interest rate gap Based on the recent interim assessment, there is no need to change our basic understanding of USD/JPY that “leaving the situation as is will lead to JPY weakness.” Strangely, at her Congressional testimony given on the same day as the BOJ MPM (July 15), FRB Chair Janet Yellen’s assessment of the U.S. price situation was as cautious as ever, which is in contrast to Mr. Kuroda’s deepening confidence about soaring prices. If one applies the theory that “a deflationary currency tends (relatively speaking) to be purchased” to this situation, one would assume USD weakness against JPY strength, but in reality, this is not the case. Given this background, it is reasonable to assume that there are moves anticipating the expected expansion of the interest rate gap. Governor Kuroda, too, taking into consideration the difference between the FRB and BOJ’s monetary policies, remarked that “the strengthening of JPY against USD is not inevitable at all,” and I can agree with that view. It is difficult to close the gap between a currency that has turned its back to an exit (from monetary easing) and another that is moving toward it. There is a high probability of USD/JPY appreciating, driven by the interest rate gap. The only question is when. As of the time of writing this report, the market forecast is around August or September 2015. Moreover, if one takes into account that in the lead up to that process, a variety of arguments will be put forward regarding excess liquidity absorption methods (imposing interest rates on the excess reserve deposit, reverse repo

2 Please see Mizuho Market Topic dated July 15, 2014 titled “Interpreting the Sakura Report.”


operations, time deposit facilities, etc), there is a high possibility of phases of USD purchasing following the October-December 2014 and January-March 2015 FOMC meetings. Only then will signs of USD/JPY stabilizing at a rate exceeding 105 will begin to appear. U.S. monetary policies now and going forward – Present rate hikes in preparation for future rate cuts? Not going so far as to say that the debate surrounding the interest rate gap and USD/JPY has begun in real earnest... At the FOMC meeting held on July 30, tapering for the predicted amount was decided, which reduced the purchase amounts of mortgage-backed securities (MBSs) and U.S. Treasury securities by USD 5 billion each, lowering the total asset purchase amount from the August USD 35 billion to USD 25 billion in September. The FOMC statement contained hawkish revisions related to employment and prices. This and the strong results for the U.S. April-June period GDP released on the same day caused USD to strengthen across the board in the forex markets. However, the statement also contained the remark that “a range of labor market indicators suggests that there remains significant underutilization of labor resources,” leading one to believe that the weak growth in wages will be used as a justification to retain accommodative monetary policies for the time being. Following the release of this statement, USD/JPY also inched up to the 103 level for the first time in three months, but there is no major change in the market’s view that a rate hike will be implemented in mid-2015 at the earliest, so one cannot go so far as to say that the debate surrounding the interest rate gap and USD/JPY has begun in real earnest. For instance, the U.S.-Japan two-year interest rate gap, which often draws attention due to its high correlation with USD/JPY, has expanded to around 0.50 percentage point as of the writing of this report. This level is the highest it has been in recent times, but still quite far from the 1 percentage point, which was the barrier at the time Lehman Brothers collapsed (see exhibit). It is, therefore, still too early to say that something new is taking place regarding the U.S.-Japan interest rate gap. In other words, the markets are currently making light of the situation with their view that an FRB rate hike is still in the distant future. Consequently, rather than the strength/weakness of U.S. economic indicators, it would be wise to assume that the focus of the markets’ attention going forward will shift to whether or not an indicator could have a direct bearing on a rate hike decision. It is easy to see that the reason USD purchasing did not gather momentum despite the June Employment Situation Summary posting strong employment growth by just under +300 K may have been because the markets judged this result as having no significant effect on the FRB’s normalization process. The present rate hike is in preparation for a future rate cut? The June Employment Situation Summary posted extremely strong results, but it is not as though the markets tilted toward greater optimism in response to it. The reason for this is conceivably because of the limited growth in wages, which is something Ms. Yellen is also worried about. Just as the hawkish revision of the assessment of prices in the July FOMC statement drew attention, going forward, the markets choose price trends among the various economic indicators on which to base their expectations regarding the normalization process. This is an important change in the sense that the single-minded focus on the employment statistics will shift. In fact, USD rates fluctuated significantly with the release of both the June and July CPI, indicating a clear increase in the

76

81

86

91

96

101

106

111

116

121

126

0

0.5

1

1.5

2

2.5

3

3.5

4

07/07 08/07 09/07 10/07 11/07 12/07 13/07 14/07

（Yen）（％）


US-Japan 2yrs bond yield's spread & USD/JPY rate（1％wall after Lehman collapse）

2yrs yield's spread USD/JPY

2.0

2.1

2.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9

3.0

Jan-

10

Apr

-10

Jun-

10

Nov

-10

Jan-

11

Apr

-11

Jun-

11

Nov

-11

Jan-

12

Apr

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

（％）

（Source）FRB, Mizuho Bank

Long -term growth rate forecast by FOMC members


importance of price indicators for the forex markets. At her June press conference, Ms. Yellen strongly pointed out that inflation figures are “noisy,” refusing to acknowledge the movements as indicating the basic trend. The OECD’s Output Gap statistics also showed a still large deflationary gap for the U.S., and it is conjectured that the FRB, too, may have this economic reality at the back of its mind. As the exhibit shows, the level of the long-term growth rate forecasts by FOMC members, which is seen as the potential growth rate, has been declining, and it is thought that the required policy interest rate level is also clearly declining in line with this. In the coming days, the FRB may gradually begin to aim in the direction of a rate hike, but given that the growth in wages is unremarkable and there is no acknowledged upside risk for the overall macroeconomic inflation rate, it is hard to see why the FRB is solemnly persisting with its tapering program and attempting to begin talking about exit strategies in concrete terms. It cannot be ruled out that the present hawkish moves, not backed by much confidence in the state of the economy, may have significance as “preparation for the future.” In the event of some major unexpected external shock (even if it is not in the same class as the Lehman shock) going forward, the FRB would have very few options if the size of its balance sheet is enormous and the policy interest rate is also at its lowest limit. The FRB would, at such a time, have to start expanding its balance sheet all over again. It will also be forced to begin working all over again on an exit strategy, which it has recently embarked on after a great deal of trouble. Again, irrespective of specific external shocks taking place, the economy itself works in cycles, and recessions, big or small, do take place at specific intervals. A day will come when monetary easing, on either a large or small scale, is called for again. In preparation for such a day, it is a good idea to have as many cards on hand as possible. The FRB’s true intention is probably to lay the groundwork for a future contingency from the aforementioned perspective: in other words, roughly speaking, it wants to raise the rates now in preparation for potential future rate cuts. If that is the case, one can give a nod of approval to the Committee’s recent words and actions, which are otherwise somewhat hard to understand. However, such an intention amounts to seeking to press the accelerator and brake at the same time, i.e., seeking a yield-curve shape signifying an increase in short-term interest rates and suppression of long-term rates – this involves a kind of policy operation that is by no means easy. Lessons from history – Waiting for selling JPY by Japanese – Is this the sixth time? “Selling JPY by the Japanese” is required for JPY depreciation phase Again, looking back at the history of JPY rates and taking into account the persistent Japanese current account surplus, the fact that over 90% of all JGBs were locked in internal debt, and that there were not that many foreign investors who would over-weighted Japanese shares, it seemed a cardinal rule that “only the Japanese had enough JPY to sell” and that “unless the Japanese sold JPY, a fundamental phase of JPY-weakness could not begin.” The context in which this cardinal rule applied is slowly beginning to change, but it remains a matter of interest both domestically and abroad to see “when the Japanese will make their move.” At what point in time will a market environment conducive to JPY selling by Japanese (≒the acquisition of risk) take shape? Such a thing would become possible only when the economy is performing well, or to put it another way, when share prices are rising. Even institutional investors (life insurance companies, pension funds and so on) would be unlikely to aggressively pursue foreign securities investment at a time when share prices are falling and appraisal losses are suffered. The figure above shows Nikkei Average and USD/JPY trends starting 1973, the year in which Japan entered the floating exchange rate system. Phases of conspicuously weak JPY (five phases numbered 1 to 5) have been encircled in red. There are bound to have been complicated circumstances leading to JPY weakness in each of these periods, but a basic correlation between a rising Nikkei Average and a weak JPY can be established, and in each of these phases, circumstances were conducive to Japanese investors taking on risk. During phase (1), in addition to USD value being propped up by the Carter administration’s USD defense program, the revision of the Foreign Exchange Act is also thought to have had a significant impact. The merger of the domestic and foreign money markets, which had until then been kept totally separate from each other, is said to have set off a major spree of risk-taking by Japanese investors. Phase (2) is, as everyone knows, the period when the Japanese economy experienced its most vigorous growth. It was also a period of extremely aggressive foreign investment, characterized by a Japanese real estate company acquiring the U.S. Rockefeller Center. This period in history also saw the Nikkei Average approach JPY40,000, and the deregulation of foreign securities investments for life insurance companies, which all created an environment extremely conducive to foreign investment by institutional investors (with Japanese life insurance companies so widely recognized that they came to be called “the seiho” even in foreign money markets). In Phase 3, Japan was able to exit a phase of extremely strong JPY. This was the period when JPY-selling interventions were intermittently made starting with the U.S.-Japan concerted intervention of July 7, 1995 and Japan’s Minister of Finance published its “Program to Encourage Foreign Investment and Financing” on August 2, 1995, once again encouraging the sale of JPY by Japanese investors.


Phase 4 of weak-JPY is somewhat exceptional in that it was triggered by the collapse of the IT bubble which resulted in share prices plunging across the developed world including Japan, and not because of aggressive risk-taking by Japanese investors. Soon after the economy went into a recession, demand for USD rose, causing it to appreciate. This combined with the intermittent JPY-selling interventions (amounting to the sale of a total of JPY7 trillion in 2001-02) and the BOJ’s QE measures to cause USD/JPY to appreciate. The most recent phase of weak JPY is Phase 5, the longest continuous period of economic growth in Japan since the end of WWII, when the Nikkei Average soared above JPY18,000, and Japan’s extraordinarily low interest rates among all countries worldwide spurred on a brisk carry trade in JPY. This was a period when, for instance, a foreign bank with a branch in Japan could procure a JPY-denominated call loan cheaply, and loan this out in turn to its parent company or other branches of the same bank abroad to be invested in assets that earned a much higher rate of interest. The downward pressure on JPY exerted by such trends cannot be ignored (see figure). Again, currency trading on margin by Japanese individual investors and foreign currency investments by individual investors via investment trusts became so common that Japanese individual investors came to be known among foreign investors by the nickname "Mrs. Watanabe." From the perspective of these foreign investors, the “Mrs. Watanabe” investors exerted an influence at par with the one-time “seihos.” Looking back at historical particulars such as the above, economic recovery accompanied by a share price increase is essential for the transition to a weak-JPY phase, and, in particular, a continuous expansion of the U.S.-Japan interest rate gap is what will make carry trade attractive. In this sense, given that consumption taxes will be increased two years in a row in 2014 and 2015, the BOJ’s posture toward monetary easing is almost certain at least through this period. Meanwhile, as described above, the U.S. economy looks poised to continue its return to cruising speed, and barring unforeseen events, balance sheet adjustments may be completed by 2015. If that be the case, the U.S.-Japan interest rate gap will enter a trend of expansion, albeit very gradual, in 2015. There are, in fact, signs that the seeds of a fundamental trend of JPY weakness have already begun to sprout. Under the circumstances, we should consider the present situation enter on the Phase 6 of weak-JPY. If there is enough yields’ spread and also adding JPY sales from Japanese, JPY weakness will be convinced but Ms. Yellen is clearly not desirous of implementing rate hikes at a fast pace. One would be wise to assume that Japanese investors, led by institutional investors, will begin to expand their exposure to open external bonds etc., at the earliest during the second half of the current forecasting period. 0

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1973 1978 1983 1988 1993 1998 2003 2008 2013

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Transition of USD/JPY rate（since January 1973）

Nikkei index

USD/JPY

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④ ⑤

⑥？


“Accidental Events” Present Opportunities for Buying on the Dips – Skillfully Coping with Narrow-Range Forex Rate Movement Volatility in response to geopolitical risks The forex market in July suddenly became dominated by a risk-off mood in response to reports of the downing of a Malaysian Airlines plane over northeast Ukraine near the Russian border, and JPY strengthened against most currencies. Given reports that all the 295 crew and passengers on the plane died and that the victims include numerous Europeans and Americans, there appears to be a very strong likelihood that anti-Russia sanctions will be announced going forward. In view of this along with reports that Israeli armed forces are concurrently launching a ground incursion into the Gaza strip, it was inevitable that market participants would perceive a heightening of geopolitical risks. In line with the standard responses to such situations, the forex market purchased JPY and the bond market purchased U.S. government bonds, sharply pushing down U.S. yields. Consequently, USD/JPY quickly descended from its peak of 101.70 yesterday and reached the level of 101.14.

Looking back at weak JPY history 　* Colored parts show time and events those accompanied “JPY selling by Japanese”(1) 1978-1984 Event Rough details of the event

1973, 1978 Two oil shocksIncrease in price of crude oil causes current account deficit inJapan. JPY begins to be seen as vulnerable to petroleum prices.

November 1978 Carter shock Dollar defense program causes USD to appreciate

December 1980First revision of the Foreign ExchangeAct

Liberalization of foreign transactions via exchange banks. U.S. 30-year interest rates of that time were 13 to 15%.

September 1985 Plaza accordG7 implements a concerted normalization of foreign exchangerates by bringing down USD rate◆End of weak-JPY phase

(2) 1987-1990

Second half of 1980s Japanese economic bubbleNikkei Average approaches JPY40,000 at one point in 1989. Assetappraisal gains of institutional investors soar.

August 1986Deregulation of foreign securitiesinvestment laws

Foreign denominated assets of institutional investors increase

February 1987 Louvre Accord Reversal of excessive USD devaluation caused by the Plaza

Since 1990Collapse of the Japanese economicbubble, etc.

Appraisal gains fall through the floor. SM regulations for lifeinsurance companies introduced in 1995

◆End of weak-JPY phase(3) 1995-1998

Second half of 1990s HF Carry TradeJapan faces financial crisis. Speculation of protracted ultra-lowinterest rates comes to the rescue.

1995Several factors causing JPY trendreversal

Washington G7 statement, U.S.-Japan concerted intervention,deregulation of foreign investment/financing, easing up of trade

April 1998Second revision of the ForeignExchange Act

Collapse of exchange banks. Prohibitions against free foreigntransactions by individuals and corporations

Aug - Sep 1998 Russian LTCM Crisis Position adjustment. Rollback in JPY carry trade.◆End of weak-JPY phase

(4) 2000-20022000 Collapse of the IT bubble Early recessionary phase, increase in demand for USD

2001-2002 Intermittent JPY selling intervention JPY sale in excess of JPY7 trillion

September 2001 Serial terrorist attacks on the U.S.JPY weakens alongside USD and U.S. shares. BOJ implementsan exceptional quantitative easing in March 2001

Since 2002 USD-carry phaseUSD becomes “ taking currency. ” Japan enters longest phase ofeconomic growth since end of WWII◆End of weak-JPY phase

(5) 2005-2007

2002-2007Longest postwar period of continuouseconomic recovery

Nikkei Average soars above JPY18,000

2005-2007 JPY-carry phaseJapan has exceptionally low interest rates among developedeconomies. Against this backdrop,Japanese individual investors ’ forex investments increase andinvestment trusts become popular

Since summer 2007 Intensification of financial crisis Position adjustment. Rollback in JPY carry trade.◆End of weak-JPY phase

(6) 2012-present

Since March 2011 Trade deficit become establishedTrade deficit break record year 2011 & 2012. Change of supplyand demand mechanism. Selling JPY by Japanese importers

February 2013 Monetary easing by BOJ USDJPY 200 days moving average started to bottom outDecember 2012 The second Abe administrarion start Abenomics. Powerful reflation policy

Since 2013 Selling JPY by investors? There is no trend has seen clearly yet

April 2013Introduction of quantitative &qualitative easing

Unprecedented quantitative easing


The theme for 2014 is don’t miss out on “accidental events” Reflecting such situations as the Ukraine crisis at the end of February, the Iraq situation in early June, and yesterday’s airliner downing and Gaza strip incursion, the rise of USD/JPY this year is being impeded by geopolitical risks. (Strictly speaking, the current situation is a part of the Ukraine crisis.) I have already commented in Forex Medium-Term Outlook on the outlook for USD/JPY during the remainder of this year as follows: “ the topic for the current forecasting period is “how best to buy the dips” when confined within a small

range – the answer: events such as the crisis in Ukraine since early this year, the turmoil in emerging markets, and the Iraq crisis that has been in the news since June, must be considered good opportunities to buy on the dips.” (Excerpt from June, 30, 2014 edition of Forex Medium-Term Outlook)

My view has not changed at all at this point. Going forward, if the situation worsens further, it is quite plausible that USD/JPY may descend below 101 and even break below the 100 level. (For the July-September quarter, Forex Medium-Term Outlook presents 99 as the prospective low and forecasts a quarter-end level of 103.) However, the disparity between the monetary policies of Japan and the U.S. has not been corrected, and Japan’s huge trade deficits have not been eliminated. Since Abenomics became a topic of discussion in the October-December quarter of 2012, we have experienced episodes of strengthening JPY appreciation pressures including those unassociated with geopolitical risks, but all the episodes have turned out to be transient despite the fears of “a return to a JPY appreciation trend” inspired by each episode. Looking at IMM currency futures trading data, for example, one finds that the balance of JPY-selling futures during the past two years has been stable in the JPY1.0-1.5 trillion range (see chart). There is a strong perception that selling JPY – the only currency with real negative interest rates – is a safe choice and, rather than emphasizing the perception of crisis associated with “accidental events” more than is necessary, it would seem smartest to view the crises as opportunities for buying on the crisis-induced dips within a very narrow range. The obverse side of this is to consider what kind of situation could possibly lead to a JPY strengthening trend not dependent on the effects of “accidental events.” If we assume the possibility of a U.S. double-dip recession accompanied by a rewinding of the U.S. monetary policy normalization process (≈ additional easing measures), for example, then a renewed trend of JPY appreciation is conceivable. Amid a situation in which the trial operation of liquidity absorption methods (such as reverse repos, time deposit facilities, etc.) has already been initiated, however, it does not really seem reasonable to consider this to be a realistic scenario. USD/JPY outlook – Situation continues to favor buying on the dips The risk is that the monetary policy operation environment could become oppressive In the above sections, I considered USD/JPY from the perspectives of recent levels, relationship with share price levels, the outlook for U.S. and Japanese monetary policies, market sentiments taking geopolitical risks into consideration, and lessons that can be learned from past experiences. As I mention in this report every month, the supply and demand situation is now, without any room for doubt, tilted in favor of JPY sale, and the U.S.-Japan monetary policy gap is also extremely wide. Given recent words and actions, it is hard to imagine that the FRB under Janet Yellen will allow any marked increase in U.S. interest rates within the year, but it is not so unreasonable to assume that there will be a phase of JPY selling and USD purchase within the current forecasting period as the U.S.-Japan interest rate gap expands. As mentioned in the above sections, rather than eagerly await a further depreciation of JPY (this will happen as a matter of course), one would do well to be concerned about the possibility that the present level of JPY weakness is already at the break-even point for Japan.

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（Source）CFTC、Datastream

IMM currency future JPY positions

Short Long Net

(One hundred million yen)

JPY long

JPY short


However, though the USD/JPY risk is undoubtedly expanding on the upside, it is not the kind of risk expected to cause rates to soar beyond 110 in the near term. At the most, the currency pair will battle back-and-forth within an extremely small range and expand its upside potential by small increments. The majority view is that any major move, be it an additional monetary easing by the BOJ or an acceleration of the FRB’s belt-tightening efforts, will take place only in October-December this year at the earliest, and no developments leading to the currency pair breaking out of its range overnight are assumed. The ongoing theme for the current forecasting period, therefore, continues to be “how skillfully investors can buy the dips” even as USD/JPY battles within a narrow range. In the near term, for instance, the strength of potential impact on the markets from “accidental events” such as the crisis in Ukraine or the invasion of Gaza is a point of significance. Keeping the likelihood of such phases in mind, this report will not rule out the possibility of the rates falling below JPY100, but even if they do, they may remain there only for an extremely short period. Incidentally, even if the rated rise to JPY110 before the end of the year (as per our current forecast, they will only reach that level during the January-March 2015 period), the range will still be around JPY9 (JPY110 – 100.76, the year-to-date low). Taking such facts into account, it seems highly likely that 2014 will end as the year of the smallest range since the introduction of the floating exchange rate system. The biggest risk I worry about is: how long will public opinion continue to support an “unreal economic recovery” invited by dependence on JPY weakness? As I mentioned in a previous section, the present level of JPY weakness is already strongly suspected to be at the break-even point for the Japanese economy. As people begin to see that “monetary easing → JPY weakening → stagnation in real wages,” the climate surrounding monetary policy operation could well become oppressive. Starting around autumn this year, when the CPI is expected to peak out, there may be increased calls from the financial markets for an additional monetary easing, but it is not certain that public opinion will go along. Even if an additional monetary easing is implemented, if the improvement in real wages fails to keep up, there may come a difficult time in the future when JPY weakens but share prices weaken. As for overseas risks, there are scenarios such as the calling off of the tapering schedule (at the pace of USD 10 billion a month) by the FRB, or the exact opposite, i.e., an early start of rate hikes. Although neither of the above extreme scenarios is foreseen at the current time, USD/JPY would probably fall sharply in the case of the former and rise steeply in the case of the latter. As for the Euro zone, there still remains the possibility of speculation regarding the ECB’s “next move” affecting USD/JPY.


EUR Outlook – How to interpret the Europe-U.S. commodity price gap ECB Monetary Policies Now and Going Forward: Remembering the BOJ’s struggle Policy change doldrums, major systemic change decision The July ECB Governing Council Meeting decided to maintain the policy interest rate (interest rate on main refinancing operations (MROs)) at 0.15%, the upper limit (the interest rate on the marginal lending facility) at 0.40%, and the lower limit (interest rate on the deposit facility) rate on the deposit facility at -0.10%, thereby keeping the interest rate corridor (the difference between the upper limit and the lower limit) at 0.50 percentage point. Although the July Governing Council Meeting can be considered much less eventful than the June meeting, it did approve major system changes – beginning from January 2015, the GC meetings will be held at six-week intervals rather than monthly, and the regular accounts of the monetary policy meetings will be publicly disclosed. As explained below, I believe that this is a skillful strategic move that will allow the ECB to make progress in its psychological war with the markets. The closely followed press conference following the GC meeting included lengthy explanations of modalities for targeted longer-term refinancing operations (TLTROs) and asset-backed securities (ABS) operations that comprised a considerable portion of the conference. Since a separate report on TLTROs was released, there did not seem to be a need to spend so much time explaining the details, but the lengthy explanations did reflect the general perception that the ECB is “counting” or “betting” on the effectiveness of the TLTRO and ABS purchasing operations. Moreover, ECB President Draghi did not conceal his irritation with the markets’ stubborn expectations of additional easing, and the series of systemic changes also seem to be closely related to this situation, which is noteworthy insofar as it reflects the BOJ-ization of the ECB – the ECB is becoming embroiled in a “word association game” with the markets (particularly the forex markets) previously besetting the BOJ. Two reasons for changing the frequency of ECB GC meetings The most important elements of the GC meeting were the decision to change the frequency of the Governing Council Meetings and the announcement of TLTRO modalities, and the press conference focused primarily on those two points. Regarding the meeting frequency change, there was a question about whether the ECB was “planning to sync this with the US Federal Reserve?” and a question (focused on below) about whether the change indicates that the “your work is largely done now and you will not have to intervene so frequently.” The first question seems to be a sarcastic reference to FRB’s impact on EUR exchange rates and the ECB’s recent tendency to respond to that impact when determining the direction of its policies. (In the same vein, this article has sometimes referred to the ECB’s transformation into the “FRB Frankfurt Branch.”) Going forward from next January, the ECB will shift to meeting eight times a year, just as the FRB, and this will naturally increase the likelihood that the two banks’ policy decisions will sometimes become less synchronized. Accordingly, even when a “FRB dovish policy decision causing EUR appreciation” situation arises, the ECB may not be able to immediately respond, and if by chance there is a “FRB hawkish policy decision causing EUR depreciation” situation, the ECB may just not have to do anything in response. As explained below, based on consideration of President Draghi’s articulated reason (1) along with the actual intention that seems to underlie that reason, it is not possible to completely preclude the possibility that such strategic points are associated with the meeting frequency decision. President Draghi gave two main reasons for changing the meeting frequency. Reason (1) is that that because the ECB undertakes medium to long term rather than short term inflation assessments, the “monthly frequency was simply just too tight,” and Draghi said that this is the main reason. This is a politely obtuse way of describing the reason, and it seems likely that the real reason could be concisely articulated as “we would like to reduce the frequency of having to deal with stubborn market expectations.” Given that the ECB is facing a situation of concurrent currency appreciation and disinflation and has already played its “prepared to use all available instruments other than QE” card, it is easy to imagine how heavy the burden of monthly meetings is for the ECB. As reflected in Draghi’s statements cited below, the ECB appears to be exhausted with having to deal with stubborn market expectations. The other reason is “logistical.” Accompanying the shift to a new meeting frequency from January 2015, the ECB plans to publish regular accounts of the meetings, and Draghi pointed out that six-week intervals between meetings will allow more time to produce the accounts properly. It is important to note that the ECB describes what it is planning to publish as “accounts” or explanations of the meetings rather than “minutes.” Draghi said that the ECB has to decide about lots of things, including whether to disclose the names of GC members voting for and against proposals, and has been discussing these issues during meeting as well as other occasions, and we will have to await his follow-up reports on this. While transparency is certainly an important element of good dialog with


the markets, it should also be recognized that it is beneficial to promote stability by judiciously choosing what not to disclose, and there is probably no need to disclose such information as that related to internal conflicts among GC members. Regarding TLTROs – EUR1 trillion is a strategic “bluff”? The July GC meeting also made progress by announcing details of the TLTROs. After singlehandedly explaining the details, President Draghi himself said “If this sounds a little complicated, I think you're right, and you will certainly get more from the briefing later on.” The details are the TLTROs are difficult to understand from a short explanation, and it would be best to obtain a more-thorough explanation at another venue. However, market players cannot disregard the fact that Draghi mentioned a specific figure that the overall take-up could reach. He noted that the first two rounds (September 18, 2014 and December 11, 2014) may amount to EUR400billion, which is the figure that he cited at the previous GC meeting, and then went on to say that the overall take up including six rounds from 2015 could amount to as much as EUR1 trillion. Given the fact that the TLTRO scheme will determine the maximum amount of funds provided based on banks’ existing loan balances, it goes without saying that it is difficult to forecast the actual amount of fund provision that will take place, so it is impossible to avoid getting the impression that presenting specific figures is a kind of strategic “bluff.” The problem here is that, if there turns out not to be much demand for the now highly touted TLTROs and the market reacts negatively to the scale of funds provided via the TLTROs, then there is a possibility that EUR may surge based on market players’ comparisons of the ECB’s balance sheet and the balance sheets of other central banks. That would be an extremely awkward development from the perspective of the ECB, but this article has argued that the possibility of such an eventuality cannot be denied. (See the June 18, 2014 edition of Mizuho Market Topic entitled “Eurosystem Liquidity and a Comparison of the Balance Sheets of U.S. and European Central Banks”.) The fixed interest rate cost of the TLTROs with a maximum length of four years will be the rate on the Eurosystem’s MROs plus 10 basis points, and it would appear that the TLTROs may be profitable if interest rates rise during those four years but could also be expensive in the case that the status quo is maintained. Given the objective of promoting lending based on the outlook that interest rates will remain at present levels “for an extended period of time,” it would seem that the 10 basis points are superfluous. President Draghi’s frustration with market expectations reminiscent of the BOJ’s struggles The most striking aspect of the July GC meeting may be President Draghi’s obvious irritation with the market’s pressures. As mentioned above, there were several indications of his annoyance, including the change of meeting frequency. For example, when a reporter asked if “the lengthening of the interval between Governing Council meetings to six weeks [is] because you feel you don't need to be meeting so frequently, that your work is largely done now,” Draghi responded as follows: Draghi: “we certainly don't think that our job is finished. Not at all. I can restate: the Governing Council is

unanimous in its commitment to use also unconventional measures, after the Governing Council just reiterated its commitment to keep the interest rates at the present levels for an extended period of time. So our job is not finished.”

Draghi: “The issue is whether we should actually have each and every month the expectation for action. Keep in mind that the expectation for action itself injects a certain market behaviour, produces a certain market behaviour which may have nothing or very little to do with fundamentals. So it could become a self-fulfilling expectation with consequences on the markets

Also, observers’ eyes were caught by the response below given to a reporter’s stubborn question about the possibility of introducing QE. Draghi referred to expectations of additional easing measures with a bit of sarcastic humor. Reporter: And my second question, in terms of the sequencing of any additional moves, do you need to take

the steps that you've already announced, the TLTROs, the ABS purchases, if you do those, before you consider anything else? Or would you be willing to step in with a QE program, for example, even before these other measures kick in?

Draghi: “if our medium to long-term assessment of inflation were to change, we certainly would use this broad asset purchase programme. So we don't have a schedule, but certainly, we first want to see the impact of this programme.... you see, that's what I meant by continued self-fulfilling expectations before. Maybe we should move to a six-month schedule rather than six-week schedule.”


The November 25, 2013 edition of Mizuho Market Topic entitled “Will the ECB also become embroiled in a “word association game”” predicted that the markets might begin playing the “word association game” by anticipating that “EUR appreciation → EUR zone economic stagnation and emergence of greater concern regarding disinflation → need for additional easing measures.” This prediction has now come true, and Draghi has indicated what he thinks of the game. Since monetary easing measures were taken to correct structural currency appreciation last November, the markets have become inveterately accustomed to the problematic assumption that “the ECB is fighting currency appreciation.” As this article has repeatedly argued, employing monetary easing to counter currency appreciation that actually stems from accumulating current account surpluses and disinflation is simply treating symptoms rather than root causes, so it will be difficult to overcome the problems by means of monetary easing. By introducing negative interest rates and refusing to take the path of large-scale QE, the ECB has probably consigned itself to the fate of continued participation in a tiring psychological war. Draghi’s statements – “The issue is whether we should actually have each and every month the expectation for action.” and “the expectation for action itself injects a certain market behaviour, produces a certain market behaviour which may have nothing or very little to do with fundamentals.” – are eminently reasonable. However, fighting unreasonable market expectations is a daunting task, and the BOJ should always keep in mind the lessons it has learned from its own struggles in this regard. EUR faces outlook of a commodity price gap – Increasingly clear perception of a EURzone lag Europe-U.S. commodity price gap grown to un-ignorable size The chart on the right shows consumer price index (CPI) and producer price index (PPI) trends for Japan, the U.S., and Europe. It shows that there is currently almost no disparity between the rates of commodity price increase in the U.S. and Japan, and that the pattern of a relatively disinflationary situation in Japan promoting the strengthening of JPY is weakening (although there is a debate about whether Japan’s commodity price increase is sustainable or not). However, the commodity price gap between Europe on the one hand and the U.S. and Japan on the other hand is growing to an un-ignorable size, and the relatively disinflationary situation in Europe is making a positive contribution to EUR appreciation. This situation is even clearer from an examination of PPI trends (The Japanese index is officially called the corporate goods price index (CGPI), but this article will use “PPI” for the sake of simplicity). The Japanese and U.S. PPIs are continuing to rise at almost equal rates of 2-3% yoy, while the EURzone PPI has been declined yoy for 10 consecutive months since August 2013. The fact that disinflation has been established in upstream portions of the EURzone economy cannot be ignored, and it can be assumed that it will have the effect of further increasing the tendency of EUR to appreciate against USD and JPY over the long term. An examination of the “history of strong JPY” shows that, despite considerable short-term volatility, it was ultimately Japan’s huge current account surpluses and deflationary tendency that determined the direction of USD/JPY, and this is an important fact to consider when forecasting EUR exchange rates going forward.

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Transition of Japan, US & Euro-zone's CPI（％, YoY, all items）

US Euro-zone Japan

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11/01 11/07 12/01 12/07 13/01 13/07 14/01

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Transition of Japan, US & Euro-zone's PPI（％, YoY, all items）

US Euro-zone Japan


Historically, the downside limit of EUR/USD has corresponded to the purchasing power parity level (see chart). When seeking to project forex rate directionality, it is not important to consider how positive or negative the nominal commodity price change rates are, because the directionality will simply be determined by the relative height or lowness of the relevant currencies’ purchasing power levels. Given this, if the current commodity price disparities between Europe and the U.S. as well as between Japan and Europe persist, it can be assumed that there will be a likelihood that the purchasing power effect that has supported EUR up to now will gradually become greater. The background factors that depressed EUR in July appear to have included a perception of rising geopolitical risks associated with Russia, and the effects of that perception may persist for the time being. However, market players should keep in mind the likelihood that the risks will progressively come to be considered factors only depressing EUR in the short-term and with only a limited ability to cause a sustained drop in EUR/USD. JPY-ization is not just an upside situation for EUR The only thing that can roll back “structural EUR buying” pressure stemming from such factors as accumulated current account surpluses and disinflation is “USD buying in response to FRB normalization,” which essentially means that only improvement in the expected returns on USD-denominated assets is likely to create a sustained trend of EUR selling. Moreover, another symptom of JPY-ization is that the relevant currency’s depreciation will not commence unless the internal-external interest rate gap actually induces external securities investments. To preclude misunderstanding, it is worth emphatically repeating that the JPY-ization concept is not limited to its “disinflation = currency appreciation” aspect but also encompasses a pattern of replicating JPY’s past behavior both when appreciating and depreciating. However, based on the recent statements and actions of FRB Chair Yellen, a sharp rise in U.S. interest rates seems unlikely at least during 2014, so, just as is the case regarding USD/JPY, even if EUR/USD declines in response to growth in the gap between EUR and USD interest rates, the decline is likely to be limited to a gradual pace.

Daisuke Karakama Chief Market Economist Forex Division Mizuho Bank, Ltd. Tel: +81-3-3242-7065 [email protected]

These materials and the content of any related presentation are confidential and proprietary and may not be passed on to any third party and are provided for informational purposes only. Assumptions have been made in the preparation of these materials and any such presentation and Mizuho Bank, Ltd. (“Mizuho”) does not guarantee completeness or accuracy of, and no reliance should be placed on, the contents of these materials or such presentation. Nothing in these materials or any related presentation constitutes an offer to buy or sell or trade and the terms of any transaction which may be finally agreed will be contained in the legal documentation for any such transaction, with such transaction being priced at market rates at the relevant time (the rates herein or in any related presentation being purely illustrative). (As a general rule you will not have a right to terminate early any transaction entered into – if you wish to do so, losses may be incurred by you.) These materials and any related presentation should not be considered an assertion by Mizuho of suitability for you of any transaction, scheme or product herein or therein. Mizuho has no duty to advise you on such suitability, nor to update these materials or contents of any related presentation. You must determine in your own judgment the potential risks involved in the transactions outlined herein or in any related presentation (taking professional financial, legal and tax and other advice) and whether or not you will enter into any transaction that may arise from these materials or related presentation. Nothing herein or in any related presentation should be construed as providing any projection, prediction or guarantee of performance or any financial, legal, tax, accounting or other advice. Mizuho shall have no liability for any losses you may incur as a result of relying on the information herein or in any related presentation.

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（Source）Datastream、Bloomberg、※CPI based（JAN 1999 standard ）

Transition of EUR/USD purchasing power parity & real rate

Purchasing power parity

EURUSD rate

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