USD/JPY dropped sharply in response to the BoJ’s policy inaction in April. The outcome eroded the market’s belief that the BoJ will be easing anytime soon, if at all, and may argue for further JPY appreciation.
We still think that policy divergence could remain a USD/JPY driver even if it has to rely on only one engine for now – the Fed tightening policy from here.
Below we assess the impact on USD/JPY of the persistent widening of the USD-JPY rate spreads expected by us and the (more dovish) market consensus. Our results point at sustained USD/JPY strength ranging from 3% to 6% by year-end 2016 and 10% to 12% by the end of 2017.
The results suggest that the policy divergence implied from our rates forecasts could push USD/JPY at 116 by end-2016 and 121 by end-2017. When using the consensus expectations, the result is a very gradual appreciation to 111 by end- 2016 and 119 by end-2017.
If we were to relax the above assumption and add some stock market outperformance, presumably on the back of more government stimulus and/or further BoJ easing, this changes the results to a degree. Assuming that Nikkei revisits its recent highs around 18000 – a fairly conservative assumption – it could lift our projections for USD/JPY to 118 by end- 2016 and 123 by end-2017. When using the consensus rates forecasts, we arrive at 113 by end-2016 and 121 by end-2017.
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