Eyes of the World Should be on the BOJ

As the markets tread into the ‘post-Brexit’-world after the UK voters cast in favor of the United Kingdom leaving the European Union, the chips are beginning to fall and countries half a world away are feeling the effects of the decision. There have been many financial market effects felt around Britain and Europe, but as the aftermath sets in, the rest of the world is feeling the rumbling too.

The special drawing rights reserves held by the International Monetary Fund heavily involve the British pound and the euro, 48.7% of the reserves are held in these currencies. With the depletion of the British pound and the euro came the rise of the Japanese yen and U.S. dollar as safe havens for investors weary of the chaos in Europe. The surge in the U.S. dollar has led to the depletion of oil prices.

The shock to global markets continued, and the precise time when the markets will fully settle into a post-Brexit realm of stability is yet to be determined. Oil bulls will have to wait until the currency market settles to determine when oil will increase in value again.

A New Wrinkle:  Strong Yen Stirring Up Trouble

The series of events that led from the Brexit ‘leave’ vote to the depletion of oil prices has a new wrinkle.

The Japanese people and their yen have found themselves in a unique position following the UK vote. A consequence of the vote and the plethora of investors seeking safe haven, the yen has wandered into territory that isn’t desirable for the Bank of Japan (BOJ). The yen’s spike is creating headaches for Japanese policymakers, who worry about the damage it could inflict on exports and an already fragile economic recovery.

Japan, the third largest economy in the world, has been in the midst of a recession. In January 2016, the BOJ moved to revive growth by moving to a policy of negative interest rates. The move was made to address lagging inflation and to keep the currency stable. Given the fragile predicament of the economy, Japanese leaders have been keeping an especially close eye on the value of the Yen and are prepared to intervene if needed.

The increase in value for the yen has the potential to offset the balance of exports leaving the country. A strong yen means that prices will escalate to trade partners, which has the likely effect of a decrease in demand for Japanese goods. Should the yen continue to strengthen and the demand for Japanese goods slump, the BOJ will move to devalue the yen by selling off reserves of the currency to help mitigate the effect of investors buying in to the currency.

The crux of the situation for oil and gas minded investors is that if the BOJ moves to stabilize their currency and devalue the yen, the ripple effect of the Brexit decision will continue to push oil lower. Should the yen be devalued, the number of safe havens will be diminished and the likely alternative is investors piling in to the U.S. dollar. The consequent surge in the U.S. dollar will in turn push oil prices even lower.

The Brexit vote, rather than supply/demand metrics, has been largely responsible for pushing the price of oil lower since the decision to leave the EU came out. The continued volatility will affect the oil markets and the price of oil depending on which direction currency values move. The eyes of the oil and gas world should be paying attention to the actions of the Bank of Japan, as the next major catalyst may come from the Far East.

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