In Japan It's Going to Take Another Round of QE to Weaken the Yen

Last week we analyzed here one reason why the yen has not fallen more, despite all the QE and investor expectations for a much weaker yen. In that post we argued that in a world of zero interest rates and low inflation it's the relative size of central bank balance sheets that seem to be the main factor driving the level of currency pairs. When one compares the relative size of central bank balance sheets and a logical forecast for the relative size for 2014 and 2015, it becomes clear that the JPY/USD cross, at 102, is already discounting further monetary debasement in Japan.

In this post, instead of analyzing the relative size of central bank balance sheets, we'll look at the relative size of the monetary bases in the US and Japan. We also incorporate into our analysis a low and high forecast for the relative monetary bases. Our low forecast assumes the BOJ continues to create base money at a rate of roughly ¥70tn per year for the remainder of 2014 and 2015. Our high forecast assumes the BOJ doubles its base money creation starting in November of this year and so begins to create money at a rate of ¥140tn per year. In both cases we assume the Fed concludes its tapering process by the end of the year.

What we notice is that the JPY/USD cross discounted almost immediately the entirety of the BOJ's current QE program and at the current level the cross actually appears to be discounting even more easing than the current level of relative monetary bases would imply. To us, this means that since the market has already more than fully discounted the effect of the taper and the BOJ's planned asset purchases, it's going to take even more easing by the BOJ to push the yen lower. If the relationship between relative monetary bases and the JPY/USD  holds, then a doubling of the BOJ's bond buying program would put the yen at 120.