USDJPY: Has the sun already risen? - TDS

Mazen Issa, Senior FX Strategist at TDS, suggests that with USDJPY having crossed the key psychological level of 110, the question at this juncture is whether this lift-off is for real.

Key Quotes

“The next major reassessment level is 112.50 (~50% Fibo level from the June 2015 cyclical highs) but we think the rally looks increasingly tired from here, which in part has been exacerbated by a robust short cover. There are several reasons to believe that this move is vulnerable to a pullback.”     

“We believe that the BoJ’s yield curve control makes USDJPY more levered to a moderate pick-up in global growth and inflation expectations as rate spreads become more onesided. So, it is no surprise that USDJPY has responded in kind to a sharp sell-off in USTs even though details of Trump’s pro-growth fiscal policies have been sparse. This leads us to believe there is some irrational exuberance in the market in such a short period of time. Our rates strategists expect yields to remain elevated next year, but we caution that the speed of the move could reintroduce concerns from a financial conditions perspective or real economy risks. We are watching 10y real yields as a signpost of the latter risk.” 

“Speculation has grown that the Fed may have to tighten faster. We caution in extrapolating this narrative; the move in front-end expectations should be viewed as the market recalibrating from too benign of a policy path and towards the Fed’s median 2017 dot-plot of 2 hikes rather than requiring more. Indeed, the Z6/Z7 spread has coalesced to this view.”

“There are a litany of upcoming event risks that could upset the apple cart, leaving USDJPY pullback risk. These include: the Italian referendum (Dec 4), UK Supreme Court ruling on Brexit (Dec 3-4), ECB meeting and a possible taper (Dec  8). The combination of a triple bottom followed by a break of trend-line resistance on 4 Oct (established from the 29 Jan highs) and break of 107.50 (21 July high) however, strongly signal that USDJPY has put in good work that a base is in.”  

“USDJPY buying has largely occurred during the NY and London sessions, but mixed during Asia. Japan runs one of the worlds largest net IIP positions. Until the domestic investor becomes more actively involved, the USDJPY rally may lack sustainability. Rolling 3m hedging costs of swapping USD denominated fixed income to JPY continue to rise and could indicate that a sizable portion of domestic outflows, once deployed, could be unhedged. Once this occurs, our conviction in USDJPY topside would strengthen.”

“A retracement to 107.50 would be our first reassessment level to consider strategic longs, with our conviction strengthening on a move towards 105.55.”