USDJPY: This time it’s different (Part II)

By:
Peter Garnham
Published on:

The fact that USDJPY is testing its highs as the market awaits a Federal Reserve decision, one that will probably deliver more quantitative easing (QE) in the US, is telling.

For some weeks, and as previously pointed out here, USDJPY has been looking like it will finally break higher, driven by the prospect of a new government in Tokyo that looks set to use its currency as a policy tool to stimulate the economy.

After breaking out of the ¥77 to ¥80 range that held from May to November, USDJPY now looks set to trade up through ¥83.

Of course, a long USDJPY position has been an easy way to lose money in recent years. For all the problems in Japan, low US yields have kept USDJPY close to it record nominal low.

However, that link might be breaking.

Maurice Pomery, CEO at Strategic Alpha, says the carry trade is making a comeback, and macro funds and asset managers are using the JPY as the funding vehicle.

That helps to explain why NZDJPY is back to levels last seen in 2009, while KRWJPY is hitting highs not seen for a year and MXNJPY is on a steep upward trajectory.

Pomery believes it is now time for USDJPY to join the party.

He says it is interesting that with the Fed meeting imminent, with expectations high that it will signal more buying of Treasuries or mortgage-backed securities, that USDJPY is testing its recent highs.

"This is a significant shift in sentiment and I do not see the pair falling on US QE announcements anymore, which means the correlation between a weak USDJPY and low US yields is now broken," he says.

"So, from here on in we should no longer see USDJPY take any notice of weak US data either. What we do need to see is the JPY starting to reflect the dire situation the Japanese economy is in and on that basis it should be nearer ¥110 than ¥83."

Pomery says one thing that has been keeping USDJPY from rallying has been suppressed option volatility on the belief that the market has seen rallies in the currency before, only to be disappointed when there is no follow through.

 JPY vols spike higher

 
 Source: Bloomberg

However, with vols now spiking higher, that will not suit option issuers. It could potentially spark a chase for gamma that could reinforce the move higher in USDJPY.

This time it really could be different for USDJPY.