Battle of The Weakest
Over the last three months, AUDJPY has appreciated considerably with price printing one-year highs above 87 in December as JPY weakness was amplified in the wake of the US election and FOMC rate hike. However, JPY and AUD were the two worst performing G10 currencies over that period which limited both the upside and the extent of the pullback when the US finally lost upside momentum.
As high beta expressions on USD direction, it is likely that AUD and JPY will retain a substantial correlation in the short term, capping the scope for a breakout. However, AUDJPY still remains one of the more reliable barometers for risk. If there was to be a sustained correction in US equities, then this would likely lead to a break in the 84 level support. Arguably, following the sharp post-election gains, a correction could be in store.
Monetary policy is unlikely to return to markets’ main focus for a while as global risk appetite and the trade environment take center stage. There are risks in the short term of a fall back to 84 or as deep as 82 if we see a significant risk-off event. This could provide a good buying opportunity as Yen weakness materializes again once conditions stabilize and risk appetite improves over the year.
RBA Outlook
The RBA cash rate currently sits at 1.5%, which their RBA maintained at their recent December meeting whilst giving a fairly neutral statement. The meeting minutes showed that the RBA considered “the policy decisions made throughout the easing phase since 2011” including the “effect of lower interest rates on asset prices and the decisions by households to borrow, particularly given the already high levels of household debt”.
These comments have further strengthened the view that in the RBA’s eyes, the barrier to further rate cuts has been heightened. Currently, the market is pricing only a very small chance of a rate cut by June 2017, at 5% – 10%, and only 35% – 40% by year end. The skew towards favouring higher rates has clearly been impacted by the rise in global yields following the US election.
Australian Data
Australian data has roughly improved over the last two months and is consistent with an economy which, despite the contraction in GDP over Q3, is growing at a moderate pace. Employment data has been mixed but even so, the residential construction flow remains large, and the outlook for exports has significantly improved over recent months. Indeed, November saw the first trade surplus since March 2014, and there should be further surpluses over coming months.
However, one issue which might be troubling the RBA is the fact that inflation still remains at such subdued levels. Q4 inflation released overnight showed inflation at 0.5% vs. 0.7% expected, quarter over quarter, and 1.5% vs. 1.6% year over year. Despite these low figures, inflation has been moving incrementally higher.
Japanese Data
Similarly, the Japanese data flow has also improved recently. The BOJ argues that “Japan’s economy is likely to turn to a moderate expansion. Domestic demand is likely to follow and uptrend, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors, on the back of highly accommodative financial conditions and fiscal spending through the government’s large-scale stimulus measures.”
BOJ Outlook
Since 2014, the BOJ’s QE program has been steady at an 80trln JPY annual increased in the monetary base. Using USDJPY at 113, this equals a $59bln per month increase which is clearly a very rapid pace. However, the BOJ’s new focus on yield curve management means that that this pace is likely to vary and might not be so steep over 2017.
The surge in Oil prices over early 2016, coupled with JPY deterioration, has boosted Japan’s total CPI to 0.5% in November, from below 0% previously. This marks the highest level since April 2015. However, CPI ex-fresh food and energy was only 0.1% YoY in November, down from 0.6% in q1 2016 and only slightly above lows in 2013.
Policymakers in Japan remain plagued by weakness in wage growth and are still waiting for a “virtuous cycle” of rising wages, inflation and spending. BOJ chief Kuroda has been increasingly questioned about whether inflation will hit the bank’s 2% target before his term ends on April 8th 2018.
Technical Perspective
AUDJPY has currently stalled at bearish trend line resistance from the November 2015 highs and is potentially putting in a near-term double top. If the price does break down from the current level, A pull back to around the 80 level will be a good area to look for long opportunities as the level might prove to the be right shoulder of a large inverse head a shoulders pattern, suggesting a move back up the 90 level.