Derek Halpenny, European Head of GMR at MUFG, explains that the scope for yen depreciation was limited and the nominal yield spread was an unreliable driver of USD/JPY and after a yield spread-induced bout of yen weakness, the moves tended to reverse once the yield spread stabilised.
Key Quotes
“The fact that USD/JPY was trading around 120.00 when the Fed first raised rates in December 2015 is a good illustration of this. An important counter to the nominal yield spread has been a much smaller move in real yield spreads. The 5yr/5yr inflation swap rate in Japan basically fell from a peak of 1.40% in mid-2015 to -0.20% in mid-2016 before rebounding following Trump’s election victory but has again been trending lower since early this year. Over the same period (2015 to now) the US inflation swap is close to the same level.”
“But the inflation expectations gauge in Japan is now breaking higher. It broke to its highest level since early June yesterday and is about 25bps higher since toward the end of September. As can be seen below, the real yield spread has broken higher and is now at a level last seen (on a sustained basis) in March when USD/JPY last traded above the 114.00 level (again on a sustained basis).”
“The factor that has perhaps held USD/JPY back has been the correction lower in Japanese equities. The Topix index surged in September and October fuelled in part by heavy foreign investor buying but from a peak on 8th November corrected 4.1% lower but has since stabilised with now two days of modest corrections back higher. If global and Japanese equity markets are now through this correction lower, we may well be on the cusp of a correction higher in USD/JPY.”
“The one concern we have is that our broader view of the dollar is not consistent with a lurch higher in USD/JPY. The widening real yield spread in favour of USD/JPY could in an environment of less favourable dollar sentiment mean USD/JPY merely remains broadly stable. This would still imply yen weakness but more versus nondollar crosses.”
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