Yen Tipped to Experience Fresh Bout of Strength but Ultimately seen Lower Over Later Months
USD/JPY could slump to 108 briefly in April as a slew of high risk political events could lead investors to hedge using the safety-linked Yen.
The exchange rate is quoted at 110.66 at the time of writing.
But longer-term the pair is likely to resume appreciating, with 120 in sight as the Dollar continues its resurgence.
Both Deutsche Bank’s Taisuke Tanaka and Bank of America Merrill Lynch’s (BofAML’s) Shusuke Yamada share a similar view of the ‘u-shaped’ course the pair is likely to take.
Tanaka suggests a more lateral short-term outlook, however, with the pair probably remaining range-bound initially.
“We believe the USD/JPY will remain in a 111±3 range in the short-run. We do not rule out the possibility of a brief slump to 108 in the recent cautious and nervous markets,” says Tanaka in a note to clients seen by Pound Sterling Live.
108 is also a possible target in a short-term slump for BofAML’s Yamada:
"If the USD/JPY breaks 110, the point at which our standing recommendation stops out, an extension to 108s is a technical possibility. However, in our view, unless such a dip is accompanied by a significant deterioration in economic fundamentals, its duration should be short."
Current JPY Strength Due to Risk Aversion and Hedging
The Yen’s current strength is essentilly short-term in nature.
Analysts cite a number of reasons for the rise, including to the proximity of risky events in the form of the French Presidential elections, Brexit and potential global flashpoints in Syria and beyond.
Hedging demand from Japanese exporters is also cited as a factor.
“What could have driven this potentially outstanding JPY strength? One potential driver is a set of upcoming global risk events that may have not been captured by the model factors but could have influenced the JPY demand/supply and risk assessment,” says BofAML’s Yamada.
Meanwhile Japanese exporters are increasingly selling the Dollar and Buying the Yen in response to the possibility of the recovery in USD/JPY.
Hedge funds have also been unwinding their high level of Yen shorts which they accumulated after Trump’s election.
A Yen 'short' is a contract taken out with a broker with the aim of profiting on an assets decline. Therefore, selling that contract creates demand and sends the asset higher.
“Since the beginning of this year, our study shows relentless unwinding of JPY shorts. In the CFTC data, unwinding is more moderate but the net short position is now 40% less than its December peak,” said Yamada.
April Could See Increased Demand for Yen
The Yen is used as a safe-haven in times of crisis and there are many political events on horizon which could cause such cause a global upset, notes Tanaka:
“Politically, we await the announcement of the US Treasury Department's report on Foreign Exchange Policies of Major Trading Partners, the first US-Japan economic dialogue (18-19 April) and the French presidential election.”
After recent sabre-rattling over Syria and Gibraltar the Yen could also see increased demand if geopolitical risks remain high.
“April brings a series of risk events, including Kim Il-sung’s birthday (15 April) amid elevated geopolitical risk in the region, the French presidential election (23 April), and the US Treasury’s semiannual currency report and the funding deadline (late-April). Locally, Japan and the US are expected to start discussion on economic cooperation when Vice President Pence visits Japan on 18-19 April,” notes Yamada.
However, assuming these risk events dissipate without major upset the Dollar should start to recover versus the Yen in the medium-term.
In the second part of the year, however, the USD could be helped higher by seasonal impact due to increased foreign bond purchase by insurance accounts during the early part of Japanese fiscal year.
Dollar Strength to Return
However, longer-term Tanaka is sure the Dollar will start to take over again and drive the pair higher:
“Over the medium term, we maintain our belief that the Trump administration's promised tax cuts, even if only partially realised, would further strengthen the US economy, prompting a steady monetary tightening by the Fed and upward path in the USD/JPY,” says the Deutsche Bank analyst.
Likewise, Yamada also believes Trump’s promised tax reforms will materialise pressuring the pair higher.
“While our bullish stance on the USD/JPY since late-January has not materialised yet, we believe the medium-term upward trend in the USD/JPY has not ended. The JPY’s strength year-to-date looks overdone to us, and our team sees a high probability that tax reform will be implemented this year and the US-Japan policy divergence will deepen, widening US- Japan interest rate spreads,” says Yamada.
US Government Bond Yields Indicate USD/JPY at 117
The main driver of the uptrend in the USD/JPY in the initial stages of the Trump Rally was the rise in treasury yields, according to Tanaka, “and a 10y yield of 2.6% is seen as consistent with a USD/JPY rate of ¥115, and 3.0% with ¥120,” notes the analyst.
Given a forecast of 10yr Treasury yields to reach 2.75% in next 3-6 months, by Deutsche’s rate strategist this would forecast a currency rate of ¥117, which not quite as high as Deutsche’s official forecast of a rise to ¥120-125 within the year.
However, an increase in the ‘Carry Trade’ due to the growing differentiation between US and JPY yields would be likely to push the pair up even further that the simple correlation with Treasury yields suggests.
“In addition, we believe the driver for the USD/JPY will shift from UST yields related flows to the spread between US and Japanese short-term rates (yen carry trade), and reiterate our view that the rate will try the over-¥120 level in 1H 2018,” concludes Tanaka.
