FX Compass: U.S. and Japan: Similar Situations but Different Outcomes
U.S. and Japan: Similar Situations but Different Outcomes
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Andrew Kositkun Senior FX Advisor
The COVID-19 crisis has led to a sharp increase in savings in key developed economies as cash subsidies and other government policies temporarily increased household incomes while lockdown measures constrained consumption. In past commentaries, we have written about how this “excess savings” could be another catalyst for growth in the U.S. once the economy sufficiently reopens.
Japan has also seen an increase in its savings rate. Since 2016, Japan’s savings rate held stable around 1% of GDP. This savings rate then increased to 4.4% of GDP from October to December 2019 after the October 2019 consumption tax hike. The big jump came between April and June 2020 as the savings rate soared to 21.8% as a result of the COVID-19 pandemic.
In Japan, however, the boost to consumption from the drawdown in crisis-era savings is likely to be comparatively limited. This is because the increase in Japanese household savings during the COVID-19 shock was not just due to supply-side drivers, such as forced constraints on spending from lockdown measures, but also due to precautionary savings motivated by a deterioration in household sentiment.
To determine the share of pandemic-driven savings attributable to precautionary moves, analysts used a factor analysis based on work done by the European Central Bank. According to this analysis, more than half of the jump in savings in April through June 2020 was caused by drivers that can’t be explained by any specific factor. In essence, this should reflect the impact from voluntary self-restraint. For scope, Japan’s more than 50% of excess savings attributed to precautionary measures is higher than the 30% estimated in Europe and significantly higher than the 12% estimate for the U.S. Of course, a simple comparison oversimplifies the situation, but it is reasonable to say that precautionary motives play a much bigger role in driving the savings bubble in Japan than they do in the U.S.
Household sentiment is another important factor to consider when forecasting the path of consumption overall. On this dimension, Japan is also facing challenges, as its consumer confidence index remains stuck near the lows seen during the global financial crisis. Given that it has taken several years for consumer confidence to recover back to pre-crisis levels after previous shocks, consumer sentiment is likely to remain weak in Japan for a while. Meanwhile, Japan is behind other countries in vaccinating its population, and the government remains cautious about providing additional stimulus that could boost household sentiment.
Putting it all together, the structural increase in precautionary savings should keep the savings rate in Japan relatively more elevated, leaving the Japanese economic recovery to be driven by exports while the recovery in consumption remains sluggish especially compared to other countries with similar buildups in excess savings.
Global Perspectives is now available as a podcast.
This Friday marks the beginning of the Lunar New Year – the Year of the Ox. In China this is usually marked by somewhere around 170 million workers going home to celebrate. This year that travel is constrained by Covid restrictions. It is one of a few reasons why the People’s Bank of China seems to be shifting course in liquidity injections. Andy explains how that came about and where China goes from here.
One- to two-week view: The euro should remain range bound with downside risks in the coming weeks amid a lack of major changes in the current market narrative. Expect markets to remain cautiously risk on, thus U.S. dollar negative, given hopes for additional fiscal support in the U.S., no major change in U.S. tax policy in the near future and Fed Chair Powell’s confirmation of low rates for now. However, European growth continues to lag U.S. growth on the back of extended or tightening restrictions in Europe and larger fiscal support in the U.S. Furthermore, vaccine distribution in the U.S. has outpaced that in Europe. As such, a material rise in EUR/USD back to its December highs appears difficult. On the monetary front, European Central Bank officials have pushed back on euro strength, noting that there are many tools to combat euro appreciation and that markets are underestimating the odds of further rate cuts.
Three- to six-month view: With the factors that pushed the euro higher in 2020 having faded or starting to fade, gains in 2021 should be harder to come by. Moreover, the prospect of more U.S. fiscal stimulus has helped U.S. yields move higher, challenging the view that growth in the rest of the world could outpace U.S. growth. Near-term optimism on a recovery in global growth helps the euro higher but the single currency should dip into year-end as U.S. yields rise, the European Central Bank continues to fight deflation and market focus shifts to questionable domestic growth fundamentals. In essence, it is difficult to see a sustained euro rally without European economic exceptionalism and the prospects of European Central Bank rate hikes.
One- to two-week view: Two factors continue to drive the GBP: the U.K.’s status as a G10 vaccination leader with falling cases and the government’s lockdown and high-frequency data indicating that the third lockdown is having a greater negative impact than the second lockdown. As such, additional fiscal and monetary stimulus is expected in some form. On balance, the view remains constructive as the first factor should have the greater impact as the U.K. is also set to reopen its economy ahead of other EU countries. Regarding monetary policy, the Bank of England delivered a less dovish than expected hold and pushed back negative rates for the next six months but is keeping its options open after that. Finally, on Brexit, the economy continues to adjust to new border frictions, but this was always expected. Further details on services negotiations between the UK and the EU will ultimately be an important driver for sterling’s post-Brexit trajectory, but near-term price action should revolve around the race between the vaccine and infections.
Three- to six-month view: The path for the pound in 2021 will depend on the interaction between the realities of Brexit and the speed and extent to which the U.K. economy can recover from the pandemic. On the pandemic, the U.K. is in its third lockdown, which puts Q1 GDP in danger of contracting. However, the country is leading most other countries in the pace of its vaccination program, putting the economy in a relatively strong position to recover sooner than its peers. But the prospect of economic outperformance is hindered by persistent headwinds from what is a relatively unfavorable trade deal that largely ignores the U.K.’s important services sector. Certainly, the GBP is a weak currency compared to historical standards, but weak doesn’t always mean cheap, as the negative consequences of Brexit warrant a discount. This is why the pound is expected to drift lower as markets refocus on the fact that a skinny deal is still a fundamentally bad development.
One- to two-week view: USD/JPY should remain driven by broader USD gyrations, and global data releases will be primarily driven by overseas developments as markets await clarity around the Bank of Japan’s upcoming policy assessment due to be announced in March. In terms of social distancing, the latest state of emergency that was scheduled to end on Feb. 7 has been extended as expected. To the extent that an extended state of emergency leads to a sharper deceleration in economic activity and Bank of Japan dovishness, the yen will face depreciation pressure. Furthermore, the backup in U.S. rates could see USD/JPY higher, especially with progress being made on U.S. stimulus, but the core view remains to add on rallies as USD/JPY should eventually move lower due to Japan’s real interest rate advantage.
Three- to six-month view: The move higher in U.S. yields has interrupted what was a fairly linear decline in USD/JPY. Nevertheless, the medium-term view on the yen remains informed by inflation-adjusted rate differentials that support continued yen strength. Japan’s state of emergency should result in increased headwinds for growth and inflation. As a result, real yield spreads and relative U.S.-Japan inflation expectations continue to support yen strength.
One- to two-week view: Canada’s latest jobs data disappointed market expectations at the headline level, but the CAD remains fairly resilient due to employment losses almost entirely in part-time jobs, with full-time employment remaining stable. So while the data might point to negative labor market dynamics, the overall impact is less negative than headlines suggest. On the virus front, Canada stands out in terms of most doses procured per capita, with greater fiscal spending and stronger growth in the U.S. also providing support to the Canadian economy through increased export growth and investment activity. Previously, the CAD also benefited from broad dollar weakness, but that has since taken a bit of a hit. The CAD remains susceptible to global risk sentiment in the near term, but the medium-term outlook remains constructive as increased immunization supports increased mobility, external demand and oil prices.
Three- to six-month view: The loonie should remain driven by market sentiment and is expected to continue to strengthen through the year as domestic factors continue to improve. Specifically, Canada’s domestic outlook has improved due to improved odds for U.S. fiscal stimulus and its spillover effects. In essence, Canada’s proximity to the U.S. and correlation between longer-end U.S. and Canadian yields should see Canada benefit more than its DM peers. While the Canadian energy sector will feel some pain from the elimination of the Keystone pipeline, the improved global outlook and actions from OPEC+ give support for the outlook on oil and should allow the Canadian energy sector to benefit without being tethered to OPEC+ production constraints.
One- to two-week view: While recent indicators show China’s economy continuing to grow, there has been a moderation in the pace of this growth as illustrated by recent PMI numbers. Nevertheless, relative economic outperformance, a current account surplus and relatively high yields form the base for a bullish view and support a continued drift lower for USD/CNY. Eventually, COVID-19 vaccine distribution will allow the rest of the world to close the growth gap, but a persistent yield advantage and strong foreign investor inflows support further gains.
Three- to six-month view: Yuan strength has extended into 2021 largely as expected and should continue with appreciation driven by supportive fundamentals and solid fund inflows. China’s export sector has outperformed, and an imminent reversal of this is unlikely given the global COVID-19 situation and slower-than-expected vaccine rollout. On the flows front, bond inflows remain solid and should continue given China’s relative yield advantage. Recent weaker-than-modelled CNY fixings have garnered some attention, but it’s too early to extrapolate this into a shift in policy stance as the People’s Bank of China is expected to remain accommodative to support growth for the foreseeable future.
One- to two-week view: Risks for the AUD remain to the downside. The Reserve Bank of Australia (RBA) met this past week and stood pat on its policy path, extended its QE program by an additional AUD$100 billion, and illustrated its commitment to keeping rates low and hitting its inflation target in what was a very dovish meeting. While some key economic indicators (employment, inflation, growth) point to a stronger domestic outlook, uncertainty remains high. Case in point: the COVID-19 resurgence and re-tightening of restrictions in China could potentially weigh on the AUD. On the valuation side, the AUD’s valuation is rich, meaning valuation is less supportive, and the RBA’s balance sheet expansion should see Aussie bounds outperform U.S. treasuries. Countering this has been the AUD’s sensitivity to equity markets that remain supportive.
Three- to six-month view: Recent price action has been driven by strength in key commodity prices, with iron ore being a particularly important catalyst. However, the bias remains to see the currency move lower as the real yield compression story runs out of steam and the U.S. dollar gains support from additional fiscal spending. Regarding trade, Australia-China trade tensions should continue to linger but, critically, China is not expected to put restrictions on iron ore due to the lack of alternative supplies. Finally, the Reserve Bank of Australia has historically been more concerned with relative performance than absolute levels. Therefore, while the currency level is not optimal, it is unlikely to be a major monetary policy consideration in the near term.
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