Yen's stunning 17% surge in 2016 threatens to wipe out 3 years of stimulus

A picture illustration showing Japanese 10,000 yen notes.
A picture illustration showing Japanese 10,000 yen notes.PHOTO: REUTERS

TOKYO (BLOOMBERG) - What was the extreme bullish scenario among yen forecasters at the start of 2016 is now close to the base case - and even that may turn out to be too cautious.

The boldest forecasts for gains underestimated the Japanese currency's strength in the first half of 2016 by at least 10 per cent. The yen exceeded all estimates as investors sought it as a haven after events that most considered unlikely came to pass - from Britain's decision to quit the European Union to Donald Trump's emergence as the presumptive US Republican presidential nominee. Strategists are still catching up, with June seeing the biggest monthly boost in year-end predictions since 2008.

"Things we never envisaged have happened - risk scenarios with extremely low probabilities have become reality," said Masafumi Yamamoto, the chief currency strategist at Mizuho Securities Co. in Tokyo. "The assumptions on which we built our outlook have shifted since the start of the year. That's especially clear in the case of Brexit."

A dash for the relative safety of Japanese assets by domestic and foreign investors alike spurred the yen to a 17 per cent gain in 2016, its best first half of a year since 1995. The currency strengthened as far as 99.02 per US dollar last month for the first time since 2013, leaving it as the year's second best-performing major currency.

That's a concern for Japan's policy makers because it threatens to wipe out the effects of more than three years of central-bank stimulus, which a year ago sent the currency to its weakest level since 2002. Bank of Japan Governor Haruhiko Kuroda remains on the wrong side of his 2 percent inflation goal as a key measure of consumer prices fell for a third month in May.

Mizuho Securities is emblematic of how forecasters have been caught off guard by the yen's advance. The brokerage has updated its estimates five times in 2016, and twice in June. From a yen bear predicting a decline to 125 by year-end, it now sees a gain to 97.

A Bloomberg survey has the currency weakening to 107 per dollar by year-end, from about 102.62 as of 8:27 am in Tokyo Monday. That prediction tops the most bullish estimate at the turn of the year: JPMorgan Chase & Co.'s 110 call. Now it's Barclays that's the most aggressive bull, predicting a rally to 87 this year - a level not seen since January 2013, three months before Japan launched its stimulus program.

PineBridge Investments Japan, the PruLev Global Macro Fund in Singapore, and UBS Group are among companies to have used the term "black swan" in reference to the Brexit vote, which at one point on June 24 had the yen soaring to its biggest gain since February 1973, when it was first allowed to float freely.

Fragile global growth and a Federal Reserve that's now seenas unlikely to raise rates until 2018 are also supporting Japan's currency.

And up to now the yen has largely resisted officials' efforts to talk it lower. Japanese Prime Minister Shinzo Abe met with cabinet ministers and central bankers following the UK vote, urging Kuroda and Finance Minister Taro Aso to keep a close eye on markets.

While speculation has mounted that the BOJ will expand stimulus at its policy meeting this month, if not sooner, analysts see limited scope for this to push down the yen. The adoption of a negative deposit rate this year failed to curb its gains - and may have contributed to its strength.

As for the rest of 2016, JPMorgan sees the US presidential election as the most important flash point for the dollar-yen pair. The contest has taken a protectionist turn, not only because of Trump, but also because of the unexpectedly strong support for self-proclaimed democratic socialist Bernie Sanders.

"Between October and December the race is likely to really heat up, and amid the dollar weakness that ensues, the yen could break 100 again," said Tohru Sasaki, the Wall Street firm's Tokyo-based head of Japan markets research, who's been among the most accurate forecasters of the currency since 2013.

After that, "it'll be a question of whether it settles into the 90s then, or if it happens next year."