A call for USD/JPY to tumble towards 90 and the first warning shots from the US

Monday 2nd May 2016

A call for USD/JPY to tumble towards 90 and the first warning shots from the US

ref :- "Yen Under Pressure to Extend World-Beating Rally against Dollar" , Bloomberg Online

Quite a few major marketplaces are closed today for the May Day / Labour Day bank holiday, but there's no mistaking what's grabbing most of the intra-day headlines. USD / JPY has traded as low as 106.15 this morning (last at 106.60), the lowest point for the dollar / strongest for the yen for 18 months. Some pretty big names are calling for it to push through 100 and perhaps the only surprise is that the median estimate of the year-end rate in a Bloomberg survey of analysts has only been marked down to 116 , lower than previous calls of course but seemingly still quite toppy given the bearish rhetoric doing the rounds just now.

We know why the Yen has been so strong since early in the year, even if the move sees counter-intuitive at first glance when you consider that it started shortly after the Bank of Japan went to negative interest rates : safe-haven buying of the Japanese currency whilst markets were in turmoil, and decreasing expectations of the scale of divergence in interest rates in the US and Japan. This was particularly in evidence last week after both the US Fed and the BoJ announced unchanged monetary policy decisions  --  the Fed signalling that they're in no particular hurry to put up rates, and the BoJ declining to cut them even when expected to.

If it's true that the Fed may be prepared to put up with some inflationary pressure without taking action (in order to secure growth and maintain global economic stability), then USD/JPY can head towards 90, according to Credit Suisse at any rate. That seems like a big call but in historical terms is not so dramatic when you consider a 5 yr trading range of  75 - 125 (approx.) . This market is nothing if not volatile and if US activity should pick up later in the year, it's certainly not impossible for both a short-term target approaching 90 and a year-end forecast of 116 to be accommodated.

Credit Suisse's reasoning revolves around REAL yields ..... that is to say, the returns for an investor AFTER taking inflation into account. The thinking at the beginning of the year was that rates would diverge ( comparatively US higher / Japan lower). In fact, in terms of real yields, the opposite is happening. Japan's latest inflation figure is MINUS 0.3% , in the US it's +0.8% and +1.6% for the Fed's preferred measure of core inflation (ex. food and energy). The 10yr break-even gauges of inflation (the difference in yield between a normal government  bond and an inflation-protected one of the same maturity) point to 1.7% in the US and just 0.3% in Japan. When these are stripped out of the equation, real yields are converging rather than diverging, leading to yen strength.

The tumbling USD/JPY rate may be bad news for Japan but a weak currency is just fine for the US so long as corresponding nations continue to play by their rules. To that end, news emerged late on Friday that the US had put Japan, China, Germany South Korea and Taiwan on their "Watch List". The US will enter into frank discussions and potentially seek penalties from any nations who meet three criteria :

A trade surplus of more than $20bn with the US

A current account surplus amounting to more than 3% of GDP

Attempting to depreciate their currency by buying foreign assets equal to 2% of GDP (in other words, currency intervention)

Japan currently meets the first two of these criteria, and the US is nervous about them meeting the third. Japan's Finance Minister Taro Aso has responded by saying that Japan's actions will not be constrained by being placed on the watch list.  But JP Morgan take the view that the US' move to place Japan on their list might indeed have the effect of pushing the Yen down through 100 and lower. The argument goes : if the two nations seem to be at loggerheads, that will lead the market into thinking that there's no coordination, which would lead to uncertainty, which would lead to instability, which would lead to more safe-haven buying of Yen.

Seen in that light, a year-end level of 116 looks a long way away, but those kind of things can happen in this market.