USD/JPY: Moving so much but where is the limit? – RBC CM

Research Team at RBC Capital Markets, suggests that outside emerging markets, JPY has been the biggest FX mover since the presidential election and even excluding the kneejerk sell-off on election night, USD/JPY is up more than 500pts and JPY weakness goes well beyond general USD strength.

Key Quotes

“The moves are contrary to our core bullish-JPY view (which clearly did not incorporate a Trump victory). While the election does not have particularly strong implications for Japan or Japanese policy, two factors have driven the underperformance of JPY so far and are where we would look for direction going forward.”

“Firstly, USD/JPY (and the JPY-crosses) has reverted to trading as a proxy for general risk appetite in an environment where markets are generally risk-on. Looked at on a one-month basis (now clean of that BoJ meeting), the USD/JPY relationship with general risk appetite is back to being as tight as it usually is.”

“Secondly, USD/JPY has become one of the most leveraged plays on US rate prospects in G10 FX (only NOK is more so). The beta for JPY has moved from being amongst the lowest in G10 to the second-highest. We have long suggested that JPY has become the most leveraged FX play on US short rates due to the critical role played by Japanese investors’ hedging behaviour and, in turn, the role of US rates in determining the cost of hedging.”

“We do not attempt to forecast risk appetite, but our USD/JPY view does have to take into account shifting expectations for US rates. Our US rates strategists have revised their profile for Fed rates to incorporate a hike in December and two further hikes next year (previously one). Whilst this is a material upward revision, it is only slightly more tightening than the market has already moved to discount. As such, we are not turning outright USD/JPY bullish. In the longer term, the balance of risks still favours at least a moderate rise in Japanese hedge ratios. But the trough of 92 that we forecast for USD/JPY in H1 2017 is no longer realistic, and we will be lifting that to ~100.”