2018 saw contradicting forces eventually balancing each other and returning Dollar/Yen close to its starting line for the year. The robust US economy, Fed hawkishness, the detente around North Korea and rising bond yields supported the pair. Fears about international trade, a global downturn, Brexit, and hiccups in stock markets kept the pair depressed.i
2019 will likely see a resynchronization of the US with the rest of the world. USD/JPY will probably encapsulate the prospects for the whole world, with all the other central factors such as the Fed policy, stocks, and bonds all aligned. All in all, this currency pair is set to serve as a global barometer.
At the time of writing, in the last month of the year, USD/JPY is within some 100 pips of its price at the end of the year. However, the story is more complicated.
At the wake of 2018, it was unclear how the US economy would react to Donald Trump’s tax cuts and the extra spending by the government. Moreover, Janet Yellen was still at the helm of the Federal Reserve, and conventional wisdom was that Jerome Powell would provide continuity and nothing else. Also, to top it off, Trump was still exchanging insults with North Korean Leader Kim Jong-un. A stock market crash in February triggered a significant risk-off sentiment that was well reflected in USD/JPY falling below 105.
A recovery in the stock market marked the beginning of substantial improvement. By the spring, the US economy was blossoming, enjoying a growth rate of 4.2% annualized, last seen in 2014. Moreover, it became clear that the Fed under Powell, with a new composition, was more hawkish than beforehand. Besides, relations between South Korea and the rogue regime up north warmed up and eventually led to a historic summit between Trump and Kim in June. The olive branches diminished demand for the safe-haven Japanese yen. The pair not only pared its losses but completed a gain of around 1,000 pips, nearing 115.00.
Yet while Washington offered olive branches to Pyongyang, relations with Beijing deteriorated. The Administration slapped tariffs on Canada, Mexico, the European Union, Japan, and also China. A trade truce was reached with Europe in July, and a new trade deal was reached in North America, called USMCA, in October. However, Trump hit China with new duties, and the world’s second-largest economy struck back.
Vice President Mike Pence outlined a long list of US grievances in early October, and this coincided with jitters in stock markets, signs of slowdown outside the US, fears that the Brexit deal will not pass, an ongoing clash between Italy and the EU, and no progress around North Korea. All these adverse developments weigh on USD/JPY.
The year ends with a balance between a still resilient US economy and a hawkish Fed on the one hand, and a global slowdown, and trade uncertainty on the other side.
In this overview of 2018, one factor may seem absent when talking about USD/JPY: the Bank of Japan. Inflation remained depressed in the Land of the Rising Sun, resulting in only minor tweaks in the policies of the Tokyo-based institution. At one point, Prime Minister Shinzo Abe suggested that loose monetary policy is not forever, but BOJ Governor Haruhiko Kuroda ignored it.
As mentioned in the introduction, we may see a re-synchronization of the world economy, stocks, trade policy, and the USD/JPY currency pair.
Here are the factors to watch in 2019
Markets have doubts if the Fed will raise rates in 2019, but these doubts seem exaggerated. Powell and the new voting composition of the FOMC will likely raise interest rates at least once and perhaps twice. However, these could be dovish hikes.
The Fed has two mandates. Inflation is not running too hot and nor are inflation expectations. Employment is advancing at a healthy pace, but the low participation rate continues implying that full employment is not that close.
Other economic indicators also point to a slowdown. Home sales are softening, and investment has not been ramped up despite the tax cuts.
After four hikes in 2018, the central bank may decide to take a pause and see the impact of its moves. Monetary policy reaches the economy with a lag and Powell may pause.
More importantly, in a globalized world, the US cannot remain immune to the global slowdown for too long. And the same goes for the central bank.
When the Federal Reserve stops standing out in its hawkish stance, the US Dollar will likely peak. While a consequent advance in stocks is positive for USD/JPY
Trade will likely remain a dominant theme also in 2019. The first date to circle is March 2nd when the 90 days from the declaration of the US-Chinese trade truce expires. This date may move, but relations between the world’s largest economies will continue having a considerable impact on the global economy, equity markets, and USD/JPY.
The US shares grievances about China’s practices with other countries which will undoubtedly be glad if the Middle Kingdom opens up. However, Trump managed to anger allies with duties and also by describing them as foes.
While the US President wants to move forward with balancing the enormous trade deficit, he also cares about the performance of stock markets. If he goes too far with China, shares could slide, and he may slow down his efforts.
China suffers more than the US from the trade war. An authoritarian regime needs content citizens and stability in order to maintain order. However, President Xi may choose to play on time or play the long game, waiting for markets to reverse Trump’s efforts and waiting for him to go away.
Therefore, while China has more to lose from the ongoing tensions, it may have better cards in the negotiations.
For USD/JPY, the better things get, the higher it goes. The worse relations get, the lower it goes.
Trump passed the massive cuts in 2017 under a unified Republican government. He kicked off the trade war in 2018. One missing piece from his economic promises is infrastructure spending. While Congress is split, Democrats have been supportive of infrastructure spending that the US needs. A massive government investment plan could boost the US economy alongside stocks, and USD/JPY.
However, there is a dearth of bipartisanship in Washington. Trump and Pelosi clash quite frequently. Various politicians from the Democratic Party have expressed their desire to open investigations on Trump’s business dealings, his conflicts of interest, actions that the Administration took, and other issues. They are happy with their subpoena power.
Also, the Mueller investigation into Russian involvement in 2016 continues at full force and some in the Democratic base are calling for an impeachment of Trump. During the course of 2019, several politicians will present themselves as presidential candidates, some adhering to the base.
Yet the American public is not supportive of ousting Trump and Trump prides himself as a dealmaker. He could strike a deal with Dems that would keep him safe from unpleasant probes while the opposition gets to advance their priorities. At the current environment, this sounds remote, but anything can happen in politics, such an accord could lift the pair.
The Fed, trade, and politics will likely be well-reflected in the value of shares, with the S&P leading the way, and in bonds. The benchmark 10-year Treasury bond yield is the leader, but if the economic situation deteriorates, the yield curve will grow in importance.
An inversion of the yield curve has been a reliable indicator of a looming recession down the road. The financial world is focused on the 10-2 spread, which narrowed to single digits of basis points in late 2018. In 2019, the 10-year /3-month yield will likely grow in importance, as it has proven to be a better gauge of a recession.
The correlation between stocks, bonds, and USD/JPY will likely tighten in 2019.
The Bank of Japan will likely continue its loose monetary policy as inflation remains low and the 2% core inflation target remains elusive. Small tweaks to the QQE policy are unlikely to move the needle for the pair.
However, the Japanese government may have a greater say. Prime Minister Shinzo Abe is entering his seventh year as head of state and may be in his final term at the helm. The veteran politician may try to set his legacy.
“Abenomics,” Abe’s economic plan, consisted of three “arrows”: monetary, already delivered, fiscal, mostly delivered, and reforms, in which he lagged. Without any noteworthy opponents within his LDP Party or the opposition DJP, he may push with changes to the economy that will boost the economy. That could strengthen the yen.
The boldest move would be to open the country to immigration. With an aging and shrinking population, growth and inflation could be seen alongside a boost to the population. Consequently, the yen could rally as well. Such a move has meager chances. The Japanese society may not be ready for a radical change, and the global backlash against immigration does not help either. However, given Abe’s grip on power and his desire to make his mark, such a move cannot be ruled out.
The original source of this article FxStreet.