JPY: Its crunch time - HSBC

JPY buying momentum has been strong, and in view of the analysts at HSBC, we are getting to a crunch time for the currency with 110 still in play on USD-JPY in much the same way as 1.10 loomed for EUR-USD recently.

Key Quotes

But in much the same way as we think EUR-USD is heading lower given some local dovish and political challenges, we think the JPY is likely to consolidate rather than extend its rally.” 

“The JPY remains one of the cleanest mirrors to the USD given the BoJ policy of limiting the move in 10Y yields. The vagaries of US yield movements are mostly fully captured in US-Japanese rate differentials, and USD-JPY has been highly correlated to the daily changes in the differential. The 1M correlation is 0.81, and the 3M correlation is 0.75. So a tactical view on USD-JPY is really just an echo of a view on US yields and, for now, this is being determined by the expectations for Trump’s policy progress.” 

“Our caution on USD-JPY is that while correlations have been strong, the scale of the move in USD-JPY relative to the interest rate differential has been larger than normal. We can look back at the relationship between the level of the differential and the exchange rate since the BoJ introduced its bond yield target policy on 21 September 2016. That relationship would suggest USD-JPY could be trading closer to 114 rather than 110.”

“Of course, this need not point to higher USD-JPY if you believed the gap was about to close by the BoJ raising its bond yield target. But this seems highly unlikely. Rhetoric from the BoJ has emphasised that there was little appetite for a move higher in the yield target even when US yields were moving higher. In addition, inflation remains far off target and what little inflation there is has been a function of higher energy prices.”

“So this overshoot on the downside from USD-JPY combined with our view that USD selling momentum has passed generally means we think consolidation is more likely than extension. We also think it is unlikely that the JPY will suddenly reassert its safe haven credentials. It is simply not where the action is at. Even over the last month when the market has been prompted to revisit its enthusiasm for the Trump reflation trade, the correlation between USD-JPY and the S&P500 has been a lowly 0.15. The USD-JPY fixation is on yield differentials, not the vagaries of risk on and risk off.”