USD/JPY to be at 115 by end of Dec - Nomura

Analysts at Nomura have now turned bullish on USD/JPY.

Key Quotes:

"USD/JPY performed strongly in September, breaching 114 in early October, its highest level this year. "

"When USD/JPY was trading around 106 in March, we downgraded our end-18 USD/JPY forecast to 110 (see “Weaker USD/JPY path now likely”, 8 March 2018). However, in hindsight, we were likely too pessimistic then. "

"We now judge USD/JPY will trade more strongly, forecasting it to trade at 115 at end-December."

"We also see more upside room for USD/JPY next year, upgrading our end-June 2019 forecast from 115 to 122. On top of positive price action in September, we provide four reasons for a stronger USD/JPY path into 2019."

"First, since July’s meeting, market expectations for a BOJ tightening have declined. In Q1, expectations for a BOJ tightening rose owing to the BOJ’s miscommunications. The market also assigned a strong likelihood of BOJ normalisation because there would be more central banks embarking on normalisation this year. As a result, market volatility increased unnecessarily, with the correlation between USD/JPY and rate spreads breaking (Figure 2). However, the BOJ sent a clear message to keep its 10yr yield target unchanged “for an extended period of time” in July, which lowered market expectations of near-term rate hikes."

"As a result, rate spreads between the US and Japan are now able to widen without much volatility in JGBs. As a result, USD/JPY can rise more easily as rate spreads widen."

"Second, US economic data remain strong even after rate hikes (Figure 4). We expect Fed communications to be more data-dependent, and USD/JPY to benefit more from stronger US data."

"Third, political uncertainty related to Japan has also declined. The latest US and Japan summit meeting has several positive implications for Japan, in our view . In addition, as PM Abe won the LDP leadership election, the risk of sudden changes in Japan’s policy stance has declined significantly."

"Fourth, the environment above should continue to encourage Japanese investment in foreign assets. As FX hedge costs keep rising, Japanese investors will likely consider FX unhedged based investment, which should weaken JPY into 2019. In terms of Japanese flows, the Japanese trade balance has been hit by rising oil prices."

"A major risk factor to our more bullish scenario is the resilience of risk sentiment to higher US yields. In particular, we will focus on how resilient the EM market (especially China) will be, as the Fed’s policy stance could be adversely affected by EM economies deteriorating more significantly. The US’s economic policy stance, both fiscal and monetary, will remain important for USD/JPY as usual. The outcome of the mid-term elections could lead to a positive risk scenario for USD/JPY though."