Perfect Storm for Japanese Yen Weakness

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Perfect Storm for Japanese Yen Weakness

Fundamental Forecast for Japanese Yen: Neutral

The Japanese Yen broke major support versus the US Dollar as the Nikkei 225 broke sharply higher. We think three key factors favor further Yen weakness (USDJPY strength).

An upcoming Bank of Japan interest rate decision as well as the release of minutes from the US Federal Reserve sets the stage for potentially large USDJPY swings in the week ahead. Yet BoJ Governor Kuroda seems unlikely to introduce any changes in current Quantitative Easing measures, and it would come as a significant surprise if central bank officials hint at fresh policy easing.

Federal Open Market Committee (FOMC) minutes seem more likely to force sharp USDJPY swings. There remains a fair deal of uncertainty surrounding the FOMC’s next policy moves, and all eyes will be on whether officials hint at timing of the so-called “taper” of Quantitative Easing policies. US Treasury yields and Fed rate expectations surged following a strongly positive result in October jobs growth figures. Any dovish surprises in FOMC Minutes could derail the post-NFPs USDJPY rally.

It will be critical to watch whether US yields continue higher, as correlations between rates and the USDJPY exchange rate is near its strongest on record. The Yen’s link to the Nikkei 225 is likewise significant, and the break higher in Japanese stocks coincided with the significant move in the USDJPY.

It seems almost a perfect storm as rising yields, domestic equities, and a major shift in forex trader sentiment favor Japanese Yen weakness (USDJPY gains). The key risks to our JPY-bearish forecast are subsequently clear: a reversal in Treasuries and the Nikkei would put downward pressure on the USDJPY and likely produce a similar shift in sentiment.

Absent such a reversal, we favor further Yen weakness. Indeed, our sentiment-based trading strategies have done well selling the Japanese currency versus the Dollar, Euro, and other major counterparts. Until this ‘perfect storm’ passes, we remain in favor of selling any JPY rallies (buy USDJPY dips). - DR

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