GBP/JPY Pullback Reveals Opportunity

Financial markets are mostly quiet heading into the last few trading sessions of the year, with window dressing and profit-taking prevailing as investors are keen not to add risk before the beginning of 2016. Following a spate of bad data, the Japanese Yen has been appreciating against most peers, strengthening in particular versus the Pound after disappointing traders anticipating expanded easing measures from the Bank of Japan. However, based on the longer-term outlooks for both fundamental metrics and monetary policy, the temporary dislocation to the downside in the GBPJPY pair is likely to prove a temporary correction that opens up opportunity for value investors seeking to capitalize on the continued demise of the Yen.


The Fundamental Perspective

Japan has released a slew of data that widely confirms the worsening state of the economy despite managing to avert a recession in the third quarter. A look at the recently released consumption and output figures gives an accurate depiction of the prevailing slowdown in economic activity. With industrial output falling and retail sales slumping, the impact of deflation is likely to be felt across the economy for months to come. One of the main drivers of deflation is weak consumption, as consumers opt to postpone key purchases with the expectation that prices will fall further, creating a negative feedback loop that ensures no near-term recovery. Despite massive stimulus efforts undertaken by both the Government and Central Bank, measures to resurrect the economy are facing serious headwinds.

Aside from persistent deflation that is exacerbated by weak energy prices, the easing measures undertaken by the Bank of Japan have yet to translate to sustainable GDP growth. In fact, the Central Bank seems to be experiencing diminishing marginal returns over time, meaning that each addition Yen spent on stimulus has a reduced impact on overall output. By comparison, the Bank of England ended quantitative easing years ago, knowing full well that stoking inflation would be a much more challenging task than merely easing policy. However, the United Kingdom economy continues to outpace most peers, adding to potential upside in the Pound relative to the Yen. Japan might nevertheless benefit from the recent combination of both fiscal and monetary stimulus measures, especially the latest Government spending package set to be released in the second quarter of 2016.

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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