USDJPY: Twin deficits and inflation will result in weak dollar - Nomura

USD/JPY’s plunge to levels last seen in late 2016 has caught many by surprise, but it fits neatly into a dollar downtrend narrative, according to Bilal Hafeez, Research Analyst at Nomura.

Key Quotes

“Indeed, EUR/JPY has broadly been in a range since September last year, suggesting that we are not seeing a yen- or euro-specific move, but rather a dollar move. Remember, the euro is also seeing new highs – it has recently touched its highest level since late 2014.”

"Growing twin deficits in the US typically see the correlation between yields and the dollar breakdown and also that the dollar fares poorly during actual hiking phases. Another way of looking at this is correlations of G10 FX performance against current accounts or shifts in interest rates. Here we find that current account balances have asserted themselves as the best explainer of relative FX performance just as monetary policy has lost its grip on markets.”

“As for inflation, the current combination of higher US inflation and loss of momentum in US growth surprises should weigh on the dollar. This has panned out. Again looking at correlations across a range of indicators, we find that FX is now negatively correlated with inflation levels.”

“In a world where twin deficits and inflation matter, the yen stands out. Japan has the lowest expected inflation in the G10 world. Core inflation is currently an anemic 0.1% compared with the recent 1.8% in the US. Japan is running a sizeable current account surplus and its fiscal balance is improving. Meanwhile, the US’s trade deficit is widening fast and the US is set to see its worst deterioration in its fiscal balance outside of a recession in modern history. All this suggests that dollar weakness could continue. We need to monitor the pace of the move, and Fed actions (more tightening to slow the economy) or even BoJ/ECB actions, but for now we’d look for USD/JPY to breach 100 and the euro to breach 1.30 in coming months.”