Still hope for yen bears to emerge from hibernation

By:
Peter Garnham
Published on:

Price action in the past few months has been frustrating for yen bears, but the downtrend in the Japanese currency is likely to recapture some of its momentum over the medium term.

USDJPY has fallen more than 2% this week after failing to hold above the ¥100 level, and stands around ¥97.

The price action is a microcosm of that which has prevailed since the Bank of Japan (BoJ) announced its aggressive new quantitative easing (QE) measures in April – which included a doubling of its balance sheet and the implementation of a 2% inflation target – with USDJPY stabilizing between ¥95 and ¥105.

That was preceded by a spike in volatility in the yen, which saw USDJPY rise by more than 20% after prime minister Shinzo Abe returned to power in December with a pledge to reflate the country’s economy and fight yen strength.

Indeed, the new-found volatility in the yen sparked the currency market back to life, with the world’s largest central banks reporting that FX volumes hit record levels in April.

Now, however, with the yen stabilizing, activity levels in the FX market are falling.

The three main over-the-counter FX platforms – EBS, Thomson Reuters and FXall – all recorded double-digit percentage falls in trading activity in July as they suffered the effects of reduced yen volatility.

Admittedly, thin summer trading conditions might also have taken a toll, but EBS, the main platform for yen trading, was hardest hit, with a drop in daily volumes of 31% from June.

Lee Hardman, strategist at Bank of Tokyo-Mitsubishi UFJ, says the lack of upward momentum in USDJPY is a reflection that the negative impact of Abenomics on the yen is now fully discounted.

“The lack of renewed upward momentum is likely encouraging some lightening of short yen positioning resulting in the yen strengthening modestly,” he says.

Still, despite the lightening of positioning, investors remain short of the yen. The latest positioning data from the CFTC, for example, shows speculators held a substantial $10.5 billion net short position in the yen on July 31.

That is still close to its highest level of the year and by far the largest short position held against the dollar, at just under half the total of $23.5 billion. 
Yen short positions still substantial 
 

Looking for a trigger for a renewed bout of weakness is therefore the name of the game for those who are convinced the yen will continue on a longer-term downtrend.

However, some believe August might not be the time to bet on further yen weakness.

Adam Cole, global head of FX strategy at RBC Capital Markets, says investors should beware of seasonal yen strength in August.

He says although a large proportion of Japan’s foreign bond holdings are hedged, investors typically hedge the principal, not the coupon stream, and this is a factor to watch in the coming month.

Cole notes the yen shows a statistically significant tendency to strengthen against the dollar in August.

“August has no particular significance in the Japanese fiscal calendar, but it does contain a particularly heavy concentration of coupon payments on US treasuries – Japan’s single-largest overseas asset holding by far, he says.

Although some of these receipts might be reinvested, and so have no currency effect, at least some will be repatriated and converted into yen to pay policyholders, according to Cole.

“This flow goes through in what is the second-shallowest month of the year for FX turnover – after December – and is thus a plausible explanation for yen strength in the month,” he says.

Still, seasonality aside, some remain confident the USDJPY uptrend will re-emerge.

Credit Suisse, for example, remains bullish on USDJPY, forecasting ¥105 and ¥120 in three and 12 months’ time, but recognizes that occasional pullbacks in the currency pair will challenge that view.

Currently, the bank is looking for a consolidation below ¥96.75 before USDJPY resumes its uptrend.

“Developments in both Japan and the US seem to be combining to support this view for the next two to three weeks,” says Anezka Christovova, strategist at Credit Suisse.

“Nonetheless, we recommend keeping the faith and buying the dip.”

Indeed, for now, last week’s weaker-than-expected US jobs report has prevented Treasury yields from breaking higher, with the result, as the chart below shows, US and Japanese yield spreads have been trapped in a range. 
 USDJPY versus 10-year real yield spread
 

Meanwhile, in Japan, a speech from Haruhiko Kuroda, BoJ governor, on July 29 seemed to suggest he sees no need for any new stimulus measures in the near future. Indeed, Kuroda made clear he believed Japan’s April stimulus package was on track and working as intended.

“This stance is likely to be problematic for USDJPY and Kuroda’s inflation objective in the short term,” says Christovova.

“It clearly suggests that the BoJ sees no reason to increase the pace of monetary stimulus any time soon.”

Christovova points out that Kuroda’s perception that Japanese inflation expectations are rising seems to be at odds with market pricing, with longer-dated forwards in the swap market having failed to rise above 2012 levels and in danger of falling. 
 Long-dated yen forwards do not suggest rising inflation expectations
 

Still, Christovova believes any move lower in USDJPY during the next few weeks will prove temporary.

That is because she expects the Federal Reserve to shock US Treasury yields higher by reducing its assets purchases at it September meeting.

Furthermore, she says the cumulative effect of the BoJ’s policy stance on Japanese monetary conditions is rising, with the monetary base growing at its fastest pace in 14 years. Meanwhile, she also expects the BoJ’s QE programme to push Japanese institutions to increase their allocations towards foreign assets and thus weaken the yen.

“Finally, even if the BoJ may be somewhat slow to react, we would expect it ultimately to react to any appearance of a resumption of trend yen strength, Nikkei weakness and, particularly, lower long-dated forward rates,” says Christovova.

It might be frustrating for the yen bears but now might not be the time to lose the faith.