Japanese yen likely to see further upside from current level
The Japanese yen has risen considerably in recent days, reversing some of its year-to-date losses. Interestingly, this strengthening began at a time when US data was unexpectedly resilient.
In principle, the market had turned bearish on the yen again after Kazuo Ueda was inaugurated as the new governor of the Bank of Japan (BoJ) back in April, pushing the currency to new lows in a number of crosses including EUR-JPY and CHF-JPY. Clearly, this bearishness was well-grounded, given that at its meeting on April 28, the BoJ announced a general review of its monetary policy “with a planned timeframe of around one to one and a half years”. Markets repriced accordingly, with the 10-year yield of Japanese Government Bonds (JGB) remaining comfortably within its yield curve control (YCC) target band of +50 to -50bps in recent months. This allowed the BoJ to scale back its JGB purchases from the highs seen at the beginning of the year.
However, Japanese macro-level data stands in stark contrast to recent yield dynamics. Q1 GDP growth was strongly revised upwards, with this year’s “shunto” final result coming in at 3.58%, and wages posted their highest year-on-year gains in 30 years. Cash earnings growth is pointing in the same direction and was up 2.5% YOY in May from 0.8% YOY in April. Contrary to other G10 countries, Japan’s core inflation has continued to rise over the past few months, while overall inflation dropped on the back of lower energy prices. And given the substantial softening of US inflation prints from May to June, this divergence is set to gain additional traction.
These developments have increased the pressure on the BoJ to act and normalise its monetary policy. In our view, the BoJ will likely further adjust its YCC at one of the upcoming meetings, given that the JGB 10-year yield has remained distinctly below the upper limit of its control band over the past few months. In effect, this would allow the BoJ to adjust its policy at a time when it is not pressured by the market. The fact that PM Fumio Kishida has ended speculation on a potential snap election should also help the BoJ. In light of the ongoing “broad-perspective review”, we think that the BoJ will likely label further YCC adjustments as “added flexibility” to the current approach rather than acknowledging a real change in its policy stance.
USD-JPY has mostly followed the UST-JGB 10-year yield differential over the past 12 months. Yet the pair has shown a periodical decoupling from its yield differential, with the month of June serving as the latest example. It was mainly market rumours about potential FX interventions by the Japanese Ministry of Finance that kept USD-JPY from climbing above 145. Yet several developments point to near-term strength in the Japanese yen. Given that the US 10-year yield is struggling to meaningfully break above the 4% level, the UST-JGB 10-year yield differential is unlikely to widen much from here. Combined with a possible YCC adjustment, this means that a stronger yen is significantly more likely than a weaker one. What’s more, the yen’s bearish positioning may have peaked and should become more bullish as the market reassesses the likelihood of another near-term tweak to the BoJ’s YCC policy. In our view, a repositioning could push USD-JPY much closer to 130. Lastly, we stand by our view that the yen should be well supported once the US cycle shows more signs of weakness.
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