CAD/JPY – Playing Unequal Recovery Rates


Differences in effects from the stimulus in Canada and Japan

Many experts admit that Japan’s central bank has even less economic stimulus tools at its disposal than the US Fed. In fact, in this country, we see almost permanent support for the economy, which suggests that the effect of stimulus has reached its limit.

That is especially the case given several historical precedents over the past few decades where large-scale fiscal stimulus in Japan has failed to generate a self-sustaining recovery that keeps Japan’s economy close to or above its potential growth rate for an extended period.

– “How Quickly Will Japan’s Economy Bounce Back?” Wells Fargo Securities Economics Group, August 21, 2020.

Unlike the United States, which spent $2 trillion to support its economy, but where the increase in the number of coronavirus cases this summer (about 60-80 thousand people per day) negated the effect from the stimulus program, the Japanese government allocated $2.2 trillion to support the economy and its “V”-shaped recovery. Until now, even despite the absence of a large number of infected people (less than a thousand people per day), the effect of stimulus in this country remains very modest.

Daily COVID-19 cases in the US as of August 27, 2020

(Source: Johns Hopkins University)

Daily COVID-19 cases in Japan as of August 27, 2020

Daily COVID-19 cases in Japan as of August 27, 2020

(Source: Johns Hopkins University)

Daily COVID-19 cases in Canada as of August 27, 2020

Daily COVID-19 cases in Canada as of August 27, 2020

(Source: Johns Hopkins University)

Altogether, taking into account not only quantitative easing but also fiscal incentives, as well as loans and guarantees, the size of the stimulus program in Japan exceeds 60% of this country’s GDP. In the United States, this figure is less than 30% of GDP (see the chart below).

The size of economic stimulus in different countries, % of GDP

The size of economic stimulus in different countries, % of GDP

(Source: “The coronavirus and economic policy measures: an overview,” Nordea Markets, August 21, 2020)

Canada also spent about 25% of its GDP on fostering economic growth. But here, unlike the United States, an increase in the number of COVID-19 cases did not offset the effect of the economic recovery program. So here, we see more obvious benefits to the economy.

Canada: Sharper bounce from the bottom

You should also be aware of the fact that due to the low incidence of coronavirus infections, the Japanese government introduced less stringent restrictive measures, which in theory should have positively affected its economic performance. However, in reality, this did not happen. All key economic indicators in Japan plummeted in the second quarter of 2020 by an amount comparable to the United States and other countries that were more severely affected by the infection.

Industrial production has not given any clear signals yet. After a significant decline in April and May, June data entered a positive trajectory. However, June and July data may be positive due to the effect of pent-up demand. Therefore, the indicators for August will be of primary importance. Their preliminary readings will be available on September 29 (according to the FXStreet.com economic calendar). Reportedly, the rebound in industrial production in Canada is sharper than in Japan.

Japan’s industrial production (MOM)

Japan’s industrial production (MoM)

(Source: FXStreet.com)

Canada’s industrial production (MOM)

Canada’s industrial production (MoM)

(Source: TradingEconomics)

Another important indicator for the Japanese economy is data on export, which makes up 19% of the country’s GDP. As in the case of industrial production, we are interested in the data for August, which will be available on September 15 (according to the FXStreet.com’s economic calendar). Comparing the nature of the decline and recovery of export orders, we can conclude that the fall in Canada was more rapid. Only the April figures contributed to the fall from $46.43 billion in March to $32.45 billion in April, followed by a sharp rebound in May and June. In Japan, the decline lasted three months from March to May, and only in June and July, we began to observe recovery.

Japan’s exports (YoY)

Japan’s exports (YoY)

(Source: FXStreet.com)

Canada’s exports (YoY)

Canada’s exports (YoY)

(Source: FXStreet.com)

Manufacturing PMIs for Japan and Canada

Manufacturing PMIs for Japan and Canada

(Source: Trading Economics)

Note: Manufacturing PMI data for Japan is on the right axis; manufacturing PMI data for Canada is on the left axis.

The Manufacturing PMI shows that business confidence in Canada has almost completely recovered to pre-crisis levels, while data in Japan still cannot cross the 50-point threshold.

Searching for confirmation of a faster recovery in Canada

The tensions in relations between China and the United States and the unresolved issue with a vaccine against coronavirus infection provided the primary support for the yen. Moreover, judging from the reaction of the foreign exchange market participants, after the announcement of the pandemic, the yen was a safer currency than even the US dollar.

USD/JPY exchange rate, daily time frame

USD/JPY exchange rate, daily timeframe

(Source: TradingView)

The fact that the USD/JPY exchange rate is now depreciating is mainly due to the general weakness of the US dollar as a global reserve currency, caused by the new round of quantitative easing in the American economy.

However, these factors serve more like a background. In crosses with risky currencies, for example, with the Australian dollar, we see that the yen is declining. The Aussie has already won back the entire drop caused by the March flight into safe haven currencies. The New Zealand dollar is also close to this.

AUD/JPY and NZD/JPY exchange rates, daily time frame

AUD/JPY and NZD/JPY exchange rates, daily timeframe

(Source: TradingView)

The Canadian dollar is not one of the currencies that are sensitive to risk, so its exchange rate against the yen, although showing similar dynamics, has not yet returned to pre-crisis levels. If we pay attention to the monthly chart of the exchange rate of the Canadian dollar against the yen, we will see that the historical support level of 75.00 remained intact this time. Given the current market situation, it seems unlikely that the price will be able to reverse and break it down. Therefore, the most probable trajectory of its further movement will be further growth.

CAD/JPY exchange rate, monthly time frame

CAD/JPY exchange rate, monthly timeframe

(Source: TradingView)

In Wells Fargo’s latest study (linked above), its authors point out that the recovery of the Japanese economy should begin to gain momentum in the third quarter. But in fact, we must consider the speed and nature of this recovery.

If you look at Canada, its economists draw a realistic scenario for the further development of the economy of this country. In its latest Monetary Policy Report, the central bank of Canada published its forecast for the country’s economic recovery, which looks like this:

Recovery in Canada

(Source: Monetary Policy Report, July 2020, Bank of Canada)

It also said that it “[…] expects a sharp rebound in economic activity in the reopening phase of the recovery, followed by a more prolonged recuperation phase”.

If we add a time frame to this general form of recovery, we see that the central bank of Canada expects economic activity to return to pre-crisis levels only in 2022.

Recovery in Canada, forecast

(Source: Monetary Policy Report, July 2020, Bank of Canada)

Thus, now we are just entering the recuperation phase. Japan’s central bank also expects a moderate recovery, according to its reports.

Japan’s economy is likely to improve gradually from the second half of this year with economic activity resuming, but the pace is expected to be only moderate while the impact of the novel coronavirus (COVID-19) remains worldwide.

Outlook for Economic Activity and Prices, July 2020, Bank of Japan, July 16, 2020.

In the case of Japan, it seems more likely that the initial reopening phase and the recuperation phase will look the same, representing a single low-slope solid curve rising to pre-crisis levels. In this case, the recovery process will be even longer in time.

As for the problem with the coronavirus, traders are already starting to price in the probability of vaccine development. According to Hypermind, which trades contracts for a COVID-19 vaccine, the most likely outcome is that it will be available after the first quarter of 2021.

Conclusion

In this regard, it is likely that, unlike risk-on currencies, the Canadian dollar will take longer to rise against the Japanese yen. In particular, traders are waiting for confirmation of the hypothesis of a faster and more sustainable recovery of the Canadian economy compared to the Japanese economy, which should be confirmed by future data. If economic data for August-September prove this hypothesis, traders are likely to bet more confidently on the Canadian dollar. Another factor supporting the Canadian dollar will be investors repricing the probability of a coronavirus vaccine development, which could weaken the demand for safe haven currencies.

CAD/JPY exchange rate, daily time frame

CAD/JPY exchange rate, daily timeframe

(Source: TradingView)

Using technical analysis, we do not exclude the possibility of a decline in CAD/JPY to the level of 78 and resumption of growth after that. However, the baseline scenario will be the growth of the pair to the resistance level of 82 and its successful breakout.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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