What is the outlook for Japanese Yen?

The Bank of Japan (BoJ) remains stuck in a low-inflation quagmire with no prospect of tightening in sight.

In the previous two years, it was around the mid-point of G10 currency performance and, in 2018 it was the best. You have to go back to 2017 to find a time when JPY was close to the bottom of the league table and, even in that year, it still outperformed USD. So, is JPY likely to hold on to its unusual position at the foot of the G10 FX table, or is the slide only temporary?

On the surface at least it seems easy to understand JPY’s weakness. The global economy is recovering and synchronised recoveries are usually bad for “safe” currencies such as JPY as financial assets are often in “risk on” mode and investors seek out carrytrade opportunities with the likes of JPY as the funding currency. Secondly, while some other G10 central banks have started to agitate towards tighter monetary policy as inflation has risen, the Bank of Japan (BoJ) remains stuck in a low-inflation quagmire with no prospect of tightening in sight.

According to the Standard Bank, investors might even be frightened of JPY if the BoJ were to hint at tighter policy because the Bank holds huge amounts of assets such as JGBs (over 40% of the market) and stocks (around 7.5%) such that any hints at all that the buying could stop and then be reversed, would surely hit assets hard and make JPY very unattractive. There is certainly some hard evidence that traders are not enamoured with JPY.

“If we look at the data on non-commercial trading positions the CFTC, we see that there’s been quite a build-up of short-JPY positions recently. This is a reversal of the surge in JPY longs we saw just over a year ago as the pandemic raged and risk-off sentiment hit the market. Now things have swung 180 degrees and speculative traders seem to be shorting JPY again, possibly to buy into higher-yielding currencies”, MR. Steve Barrow, Head of G10 Strategy at Standard Bank emphasized.

So, there seem to be lots of negatives for JPY at the moment and that might seem to suggest that the slide will continue with USD/JPY, for instance, likely to rise to 115 or even 120 before the year is out. However, there are also reasons to reject this view. First up the balance of payments position is very solid. The basic balance, which pits the current account against longer-term capital flows has become very supportive of JPY strength. Secondly, one thing the Standard Bank mentioned above that could weigh on JPY, wider rate differentials, may only exist in nominal terms, not real terms. For instance, if we look at the US and Japan, we see that US yields have risen relative to Japan but that’s all eaten away by rising US inflation expectations. In real terms US yields have hardly budged compared to Japanese yields in recent months. Another point is that, while the Fed will undoubtedly be first to hike policy rates, it is still currently buying assets at a very fast pace; much faster than the BoJ and, while that’s the case, JPY may not prove too vulnerable.

“If we look at forecasts for JPY, we see they are very stable indeed. The Bloomberg survey, for instance, puts USD/JPY at 110 at both the end of this year and next year and the range of forecasts is modest at 103-115 this year and 110-118 next year. In short, the rather boring trends we have seen in recent years are expected to persist with JPY (and USD) among the weaker G10 performers. We have tended to hold a more positive view of JPY; looking for 100 to be breached over the next year, or so. But that’s starting to look harder to justify now. Of course, we could see a sudden burst of global risk aversion and that could put 100 in the frame but, as long as the world continues on its recovery and reflation theme we may find that the yen does finish the year where it is now as one of the weaker, or even the weakest, G10 currencies”, MR. Steve Barrow, Head of G10 Strategy at Standard Bank forecasted.