The Yen Cannot Hold these Levels say One Bank; Yes It Can Says Another
The Dollar is likely to reassert its dominance over the Yen after its recent bout of weakness, argues a leading foreign exchange analyst.
Indeed, Japanese Yen strength is, “unsustainable” argues Hans Redeker, Chief Strategist at Morgan Stanley who adds it “is likely to be reversed in the coming weeks.”
Traditionally the Yen has appreciated on rising risk aversion; however, this relationship appears to have broken down and been replaced by other factors which are more Dollar supportive, says Redeker:
“Our sensitivity analysis shows that global risk sentiment has become less influential in driving the JPY, while rate and yield differentials have remained the dominant factors.”
The difference between Japanese and US interest rates and interest rate expectations are now the dominant drivers for the currency pair.
Currency’s with higher interest rates – like the Dollar - tend to appreciate against those with lower interest rates – like the Yen - as they attract more international capital from investors seeking higher returns or ‘yield’.
More Capital Available
On the subject of international capital, Redeker says that the Dollar is likely to benefit from an increase in the total volume of capital available.
“International availability of capital has improved, visible not only in record inflows into EM funds this year but also in cross-currency basis swap spreads tightening.” said Redeker.
Spreads tend to narrow the more buyers and sellers there are in a market – i.e. when there is increased liquidity.
The higher volume of capital is likely to increase the effect of interest rate differentials on USD/JPY, supporting the USD side to the detriment of the JPY.
Less Hedging by the Japanese
Redeker expects Japanese institutions to reduce the amount of currency hedging they undertake, specifically to insure against the Dollar rising, which involves selling Dollars for Yen (Dollar negative/Yen positive).
They may be less insistent to hedge as US rates become more likely to rise as it will cost them more in exchange rate rollover, based on widening interest rate differentials.
“Over-hedged JPY-based institutions may soon recognise that high hedge ratios do not make economic sense when US rates are rising. We project the Fed to hike rates by 150bp by the end of 2018, suggesting USDJPY will rally from here,” says the Morgan Stanley analyst.
Redeker and his team conclude with a forecast for USDJPY to reach 118 in the near term.
Deutsche Bank Bearish for USD/JPY in the Short-Term
In stark contrast to Morgan Stanley, Deutsche Bank say they remain bearish the Dollar and bullish the Yen – at least in the short-term - based on doubts about the implementation of US fiscal policy.
So far, the strong data out of the US has mainly been reserved for sentiment indicators such as the Michigan Sentiment indicator which reached a record high last Friday, however, ‘hard’ economic data has remained more subdued and this risks weighing on the outlook now that the initial Trump euphoria has died down.
“Although US economic sentiment has been improving from early on owing to expectations for the Trump's policies, movement in real economic indicators has not necessarily strengthened yet,” says Taisuke Tanaka, strategist at Deutsche bank.
This is likely to be negative for the Dollar.
Weather could also weigh on real data given the heavy snow in March.
“There may be an impact from heavy snow in March and a warm winter overall in the first quarter,” said Tanaka.
There are also myriad risk factors and impediments which are likely to make long USD/JPY positon building difficult in the near term.
“Our second factor is that the next hike in US interest rates is expected in June, so this will unlikely be a story for immediate dollar buying.
“Third, market participants are unlikely to doubt for long whether the
Trump administration can deliver its policies.
“Fourth, it will be difficult to build USD/JPY longs this month before the
US-China summit meetings, release of the US Treasury's Exchange Rate report and the first Japan-US economic dialog meeting,” added Tanaka.
He further notes French election uncertainty could also depress the exchange rate, given the Yen’s favoured deployment as a safe-haven.
Domestic Factors Positive for JPY
Tanaka notes how domestic factors in Japan are likely to support the short-term outlook for the Yen.
In particular, the promising Tankan industrial survey results point to strong economic outcomes, as does the government’s continued popularity, which intuits stability.
“Cabinet's approval rating is still relatively high, despite scandals. According to the BoJ Tankan released today, the benchmark business conditions DIs increased from December 2016 but was lower than the market consensus, and the forecast for June declined. Although USD/JPY's bullish trend path remains alive, there are still no deciding factors to boost it again,” said the strategist.
Medium-Term Deutsche are Bullish USD
The forecast for USD/JPY to fall is a short-term call, however, and for the medium term they see the pair rebuilding as Trump’s policy and stimulus promises eventually start to materialise.
“We remain positive on the US economy and interest rates, as well as on the administration delivering fiscal policy, and do not change our core bullish view of USD/JPY,” says Tanaka.
The Strategist sees the pair initially meandering within a + or – 3 point range around 111.00 but then rallying up to 115-120 in the medium term.
“The greatest risk to this view,” he says, “is of course policy failure for the Trump.”
