USDJPY can't defy gravity indefinitely

Thought of the day

by Chief Investment Office 18 Jul 2018

Relatively upbeat commentary from Federal Reserve Chair Jay Powell helped push USDJPY above 113 on Wednesday, its highest level in six months. The yen, which typically appreciates in periods of risk aversion, has instead depreciated in recent weeks even as US-China trade tensions escalate.

Those tensions are among the reasons why we now see a more moderate rise in the yen in the coming months:

  • Our view for the Bank of Japan (BoJ) to start normalizing monetary policy by end-2018 could be affected by ongoing trade tensions. The BoJ might want to adopt a wait-and-see stance in view of the ongoing US-China trade dispute, and the potential risk of US tariffs on Japanese autos, which could hurt Japan’s exports. 
  • Japan’s domestic inflation dynamics have also lost some momentum. We see an increasing likelihood that BoJ policy normalization materializes in 1H 2019 rather than our existing expectations for 4Q 2018. 
  • According to BIS estimates, the CNY represents 31% of the JPY trade-weighted index. Following the latest round of US-China trade escalation, we recently lifted our USDCNY forecasts on 11 July (to 6.7, 6.6, 6.5 over three, six, and 12 months). Against a backdrop of a more limited CNY appreciation over the next 12 months, we believe the BoJ would be reluctant to see significant JPY appreciation, in order to maintain export competitiveness vis-à-vis China. 

But while these factors may reduce the extent of yen appreciation, we expect the direction of travel to remain toward a stronger Japanese currency. We believe a long JPY position is still a valuable position to hedge against further escalation in global trade tensions. In the event of a serious intensification, it is likely that both US financial assets and US yields will come under greater pressure, and lead to a lower USDJPY. Also positive for the JPY is the typical repatriation of foreign earnings by Japanese exporters in the case of global risk aversion. Conversely, if trade disputes don’t worsen, we would expect the prospect of BoJ policy normalization to lift the yen. We now forecast USDJPY at 110, 107, and 105 over three, six, and 12 months, respectively.

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