Yen still a favourite with JPMorgan Private Bank’s Sara Yates

Sara Yates, Global Currency strategist at JPMorgan Private Bank, has picked out the yen as an ongoing favorite currency as euro and sterling weakness developed over the past week.

Euro: Italian elections create volatility

Markets like strong, reform friendly, euro area governments. Consequently, Bersani’s failure to gain control of the upper house (Senate) either alone or in a coalition with Monti, caused “risk-on” currencies and equities to come under pressure last week. Another shock was the voter swing towards the populist, anti austerity parties, PDL (led by Berlusconi) and 5 Stars which gained 29% and 25% of the votes respectively.

The political landscape still remains uncertain. Most analysts’ central expectation seems to be that Bersani’s PD party will try and establish a grand coalition with the PDL (Berlusconi’s party) and SC (Monti’s party) in an attempt to support a temporary government. But others ruminate about the possibility of the centre left (PD+SC) forming an alliance with 5 Stars. Another possibility is a new election, but if this occurs before the electoral law is changed, it may not result in a stable government being formed.

Apart from the initial sell-off, the EUR remained fairly resilient. A resilience that was also visible in the fixed income market, with Italy managing to get away all its bonds at last week’s auction with just a small up-tick in the cost (2017 3.5% bond sold with a yield of 3.59% and 2023 4.5% bond sold with a yield of 4.83%). Nonetheless, with continuing political uncertainty, weak euro area data raising expectations about looser ECB policy and the US sequester weighing on risk appetite, we see scope for near term headwinds for EURUSD.

Sterling: No longer a safe haven

Sterling did not have a good week. Monday began with the pound gapping lower at the Asian open as the market incorporated the news that Moody’s had downgraded the UK’s sovereign credit rating from AAA to Aa1. However, the sell-off failed to have legs. We believe this lack of traction was due to three key reasons. First, given the weakness of the UK economy, the main surprise was the timing of the announcement (Moody’s announced their decision late in the US day the previous Friday), rather than the downgrade itself. Second, as Moody’s now has the UK on a stable outlook it suggests no more changes to the rating for now. Third, the market was more concerned about non UK events including the outcome of the Italian election and the impact of the US sequester.

The week ended with sterling taking another leg down on more weak UK data, with the manufacturing PMI for February falling to 47.9 from 50.5 in January. The market had expected a small rise to 51. By falling below 50, the index suggests the sector contracted in February, raising question marks about the strength of domestic demand and the outlook for the economy. Moreover, the weak result raises doubts about how much and how quickly a cheaper currency can support the economy.

We continue to remain structurally bearish on sterling, particularly versus the US dollar.

Japan: The yen is still our favourite funding currency

Key news for the JPY this week was the government’s decision to nominate Haruhiko Kuroda (the current head of the Asian Development Bank) as the next Governor of the Bank of Japan (BoJ) with Kikuo Iwata and Hiroshi Nakaso as his deputies. This is a dovish selection. Kuroda has been a long term proponent of quantitative easing and has been calling for Japan to adopt an inflation target for the last decade. Similarly, Iwata has been an aggressive advocate of easier monetary policy in Japan. Nakaso’s intentions are less well known as he is an existing BoJ official. However his experience should help give the new leadership a good insight into the inner workings of the BoJ.

The next step is for the candidates to be approved by both houses of parliament. This is not a certainty since Abe’s party does not have control of the upper house. However, for the governor at least, it looks increasingly likely that the opposition party (DPJ) will vote in line with the government.

We continue to expect the BoJ to deliver looser monetary policy in the months to come, as they work with the government to boost inflation towards the 2% target. We remain structurally bearish on the JPY.

Korea: Electronics recovery despite a weaker yen

In our opinion, market concerns about how Korea will be affected by a weaker JPY have been overdone. While Korea competes with Japan in many sectors such as the automotives, there is less direct competition in the electronics market. And importantly, it is this sector which is leading the recovery in Korea. For example, Korea’s current account surplus widened to $2.25bn in January, largely on the back of a widening goods (electronics) surplus. Similarly, when adjusted for the Lunar New Year holiday, analysts suggest Korean exports have risen by 4.8% on average during the first two months of 2013.

Apart from improving economic fundamentals, we also expect further stimulus to come from fiscal policy (a potential currency positive) rather than monetary policy (a currency negative). Recent commentary from the Bank of Korea has been that they believe “rates are accommodative” and that growth risks are tilted to the upside. Thus even though KRWJPY has appreciated by around 15% since November, the Bank of Korea (BoK) voted 14-1 in favour of keeping rates on hold this month. Going forward, we expect rates to remain at 2.75% in 2013. Whereas, we see scope for incoming president Park’s administration to focus more on stimulating domestic growth (he campaigned on a platform of boosting welfare spending, helping smaller companies, creating jobs), rather than having a weakening currency bias to support exports.

Consequently, we continue to see a compelling case for being structurally long the KRW, particularly against low yielding Asian currencies, such as the JPY.


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