Having surged by more than 55% since late 2011, the rally in USD/JPY is coming to an end and it’s now time to think about going short.
That’s the gutsy call from Joseph Capurso, senior currency strategist at CBA, who believes now is the time to revert to “selling on rallies” rather than “buying on dips” when it comes to the USD/JPY.
Capurso offers two reasons to expect weakness in the pair: Japan’s burgeoning current account surplus and the prospect for further emerging market volatility on the back of higher interest rates in the US.
“Japan’s current account surplus has increased significantly in the past year from a deficit of 1.1% of GDP in Q1 2014 to a surplus of 3.4% of GDP in Q2 2015. A large current account surplus is very supportive for the yen,” notes Capurso.
“Indeed for much of the period since 1990 the trend strengthening in the yen only reflected the large current account surplus.”
Capurso puts the rebound in the current account down to two factors – weak Japanese imports on the back of commodity price declines and an expansion in Japan’s net income balance, something that he expects will become more influential in the years ahead as interest rates, and potentially stock markets, increase around the world.
Alongside support provided by a current account surplus, Capurso suggests that further volatility in emerging markets as a result of the US Fed increasing interest rates may result in the yen strengthening on the back of repatriation flows.
“Reflecting Japan’s large net foreign asset position, USD/JPY (and other JPY crosses) decreases during times of global economic and financial stress because Japanese investors repatriate some of their foreign investments,” he said.
The relationship between periods of heightened market volatility, shown by the US VIX in purple, against movements in USD/JPY is shown in the chart below.
While Capurso believes that the Bank of Japan will eventually be forced into additional monetary policy easing on the back of weaker Japanese and foreign economic data, unlike past episodes where the yen weakened in response to additional easing, he believes it would not come as a surprise to markets on this occasion.
“While we expect further policy easing by the Bank of Japan, we do not expect further easing will cause a sustained lift in USD/JPY like the BoJ’s previous two easing episodes. BoJ easing in the next six months would be less surprising than the previous two easing episodes in April 2013 and October 2014.”
Capurso suggests that a temporary lift in USD/JPY after more easing is likely, and believes another pop above 124 in the pair “would be a good opportunity to short USD/JPY”.
“We now see a much greater chance that USD/JPY reaches 110 (or even 105) rather than 130,” he states.
Midway through Friday’s trading session the USD/JPY currently sits at 120.11.
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