- The Japanese yen has rallied 5.9% against the US dollar this year.
- Deutsche Bank expects that trend to continue citing changes in fund flows, BoJ asset purchases and current valuations.
- It sees the USD/JPY falling to 100 this year before it finds support.
The Japanese yen, like so many other major currencies this year, has been rallying against the US dollar.
Its currently up 5.9% year-to-date, leaving the USD/JPY perched at 106.40.
Deutsche Bank thinks the yen is going to get stronger — a lot stronger.
“We believe the early year move was the beginning of a trend reversal lower in USD/JPY,” says Mallika Sachdeva, FX stratgeist at Deutsche.
“It is tempting to rationalise JPY strength by pointing to market volatility and the risk of trade wars. These were indeed important catalysts.
“But structural trends in FX typically have a flow story behind them, which combined with valuations and policy re-pricing can be very powerful.”
Sachdeva says there are three distinct structural trends in place that, in her opinion, will act to strengthen the yen against the dollar: recent changes in fund flows, subtle shifts in monetary policy from the Bank of Japan and the view that the yen is still incredibly cheap based on Deutsche’s valuation models.
On the first point, fund flows, Sachdeva says the “picture has changed”, pointing to the chart below.
“The basic balance in Japan has seen a rapid improvement, which the JPY has lagged,” she says.
“A resilient current account has helped, but the real turn has come in portfolio flows recently. USD denominated outflows from Japanese investors have slowed sharply, and FX-unhedged equity inflows into Japan are beginning, with parallels to the trend in Europe.”
Sachdeva also says that reduced Japanese government bond (JGB) purchases from the Bank of Japan (BoJ) as part of its quantitative and qualitative easing (QQE) with yield curve control (YCC) program present another potential tailwind for the yen.
“[The] BoJ has been quietly reducing QE purchases and we expect a further slowdown in the rate of buying to JPY40 trillion to help JPY gains this year,” she says.
“We have yet to see any material shift in BoJ front-end rates pricing, which thus remains a latent driver of future strength.”
Finally, Sachdeva says that the yen, even with its recent strength, remains excessively undervalued based on Deuteche’s modelling.
“The JPY is still very cheap,” she says.
“On our models, the JPY is in fact the cheapest currency in the world, and still more than 10% cheap to fair value. The extent of JPY gains will likely depend on local asset manager perceptions of when USD assets hold value again.”
Given those views, Sachdeva says it will likely act to support the yen, seeing the USD/JPY fall to 100 before it finding support.