USD/JPY: Dollar weakness vs. yen weakness, three scenarios for the pair – MUFG

Economists at MUFG Bank expect the USD/JPY to remain firm in the near-term, supported by the yen weakening further than the dollar. However, they expect dollar weakness to gradually outpace the yen if the dollar continues to depreciate. The USD/JPY pair is forecast to trend modestly lower through to the end of the fiscal year.

USD/JPY expected path under three scenarios

Baseline scenario (probability 65%)

“We expect the dollar will continue to weaken considering the US is posting record-high trade deficits (and current account deficits) and since long-term UST yield levels are unlikely to rise significantly. We expect the USD/JPY to strengthen in the near term. However, growing momentum for the normalization of monetary policy is likely to gradually weigh on risk sentiment. We expect the dollar weakness to outpace the yen by the end of the year. We, therefore, maintain our baseline view that the dollar will continue to gradually weaken against the yen.”

Optimistic scenario (probability 30%)

“We would expect long-term UST yields to gradually rise along with stocks if economic sentiment and corporates earnings continued to improve worldwide. In that case, we expect the USD/JPY to gain momentum as the dollar strengthened due to higher interest rates and stock markets rose worldwide (and the yen weakened due to risk on). However, such risk on sentiment would make the dollar a funding currency, meaning it would gradually come under more pressure to weaken than the yen. We, therefore, expect the USD/JPY would become top-heavy at around the 4Q 2018 high of 114.5 and then gradually decline.”

Pessimistic scenario (probability 5%) 

“We expect the dollar to weaken further against the yen than under our baseline scenario if risk-off sentiment were to increase for some reason, such as renewed fears of the pandemic continuing for the long term. In that case, we expect the USD/JPY would rise temporarily as the dollar strengthened more than the yen due to fears of a decline in dollar liquidity. However, we expect the USD/JPY would then fall back as dollar strength softened following a rapid response by central banks to inject liquidity. In addition, during periods of risk-off, the dollar is also likely to maintain a degree of strength (second to the yen), so in this scenario, we would expect cross yen rates to decline further than the USD/JPY.”