2020 will be a challenging year for Japan’s economy as muted inflation is compounded by heightened global uncertainty. The International Monetary Fund has already slashed the country’s GDP forecast three times this year, pointing to the need of extra monetary and fiscal stimulus to keep the economy afloat. In this report we will take a look at key economic roadblocks and possible measures from the government and the central bank, as well as potential impact on the exchange rate.

 

Need for stimulus

Japan’s growth dipped to its lowest in a year in the third quarter as soft global demand hit its export industry. At the same time core consumer inflation dropped to 30-month lows, putting further pressure on policymakers to act proactively. IMF’s growth projection was revised down to 0.8% in 2019, from 0.9% earlier, slowing down to 0.5% in 2020.

The fallout from the U.S.-China trade tension has taken a toll on exports which fell 9.2% in October. Domestic demand has remained robust and will help cushion deterioration in global trade, but to what extent? Prime Minister Abe’s sales tax hike has had side effects by putting a brake on consumer spending. As the world’s third-largest economy grapples with risks of a global recession, the government may roll out extra spending while managing adverse effects on debt and consumer sentiment.

The Bank of Japan had left the interest rates at -0.1 % since 2016, and in conjunction with its massive asset-buying programme, has less ammunition for further easing. Though Governor Haruhiko Kuroda has hinted at expanding the stimulus should economic conditions worsen. However, years of ultra-accommodative policy has failed to reflate prices and change public and businesses’ morale, denting the hopes that aggressive monetary stimulus will be as effective as the BOJ would expect.

 

Safe haven status

Despite all the challenges Japan’s economy has to face, its currency may see more of the upside should global sentiment deteriorates. Like gold and the Swiss franc, the yen tends to appreciate in times of difficulties. In a context of global monetary easing to avert looming recession, supportive measures from Japan might actually boost the yen, even though that is the last thing the BOJ wants to see as it will render Japanese exports less competitive.

Trade negotiations between Beijing and Washington appear to be on a touch and go. Even if both sides eventually agree on a first phase of a deal by mid-December, it is still a long way to go before total de-escalation. As President Trump’s re-election is at stake next year, his aggressive stance is likely to stay throughout the year. We may see increased risk aversion in the markets in the second half of the year, resulting in renewed safe-haven demand for the Japanese yen even though Japan’s economy is not out of the woods.

 

Technical forecast

USDJPY on medium-term recovery

The pair is in a narrowing 800-pip consolidation range after a three-year-long rally from 2012 to 2015. The rebound from August this year is likely to extend to the bearish trend line. We see strong technical resistance laying around 112 which could keep a lid on the price.

Strong catalyst could give the yen headwinds in favour of the greenback and we may see a breakout above the aforementioned resistance line. In that case, the US dollar could resume its long-term bullish trend and rally above 114 or even 118. On the downside, a stronger yen would keep the pair in range between 104 and 112, though a breakout to the downside is less likely unless there is widespread risk aversion across markets which would trigger a flight-to-safety in favour of the yen.

 

EURJPY looking to reverse its course

The euro has found strong support near its April 2017 lows of 115. As the pair rallies above the moving averages and the bearish trend line, sentiment is likely to turn optimistic. A combination of short-covering and fresh buying could push the euro higher against the yen.

The psychological level of 123 will be the immediate resistance level earlier next year. Strong bullish momentum could lead to a breakout and extend the rally towards 127 or even 130. However, should the euro fail to sustain its momentum, the downside risk would be protracted consolidation followed by a drop to the bottom at 116.