Japanese yen set to weaken in 2017 - Natixis

Nordine Naam, Research Analyst at Natixis, notes that the Japanese yen has been extremely volatile in 2016, appreciating sharply until September in reaction to heightened global risks - including the emerging crisis in January-February and Brexit in June - and to the Federal Reserve’s cautious stance, which weighed on the US dollar.

Key Quotes

“Since then, however, the US dollar has gone from strength to strength, notably since October, spurred by some good macroeconomic indicators out of the US and, especially, Donald Trump’s victory in the US presidential election. This has stoked expectations of a hike in the Federal Funds rate on concerns that inflation will rise in reaction to the president-elect’s stimulus plan. The sharp appreciation of the USD/JPY has been mainly off the back of the US dollar’s rebound. The yen has also been weakened by the squaring of long yen positions accumulated by speculative accounts over the course of the year whenever there was a spike in risk aversion. This last factor contributed to the USD/JPY’s technical rebound.”  

“At the same time, the action of the Bank of Japan has been a factor in the yen’s decline. When it met on 21 September, the central bank announced that its monetary policy would be focused on yield curve management. Since that date, the central bank has intervened to maintain the Japanese 10-year rate around zero percent. This monetary policy means that the Bank of Japan will stage significant interventions and buy Japanese government bonds to keep the 10-year rate close to 0%, even as long interest rates rise, more particularly in the US, but also more generally at global level. These interventions will cause the central bank’s balance sheet to balloon, lead to stronger growth in the money supply, and drive down the Japanese yen.”

“The sharp upturn in US long rates since Donald Trump’s victory has not pushed up Japanese long rates because of these interventions by the Bank of Japan. There follows that the spread between US and Japanese long rates has widened further, weighing on the yen. This divergence in monetary policies and in long rates will probably fuel capital outflows out of Japan and into the US as investors reach out for yield, which will weigh heavily on the yen.”

“In 2017, we expect the USD/JPY to appreciate further on the back of an invigorated US dollar (three hikes in the Fed Funds rate expected next year) and the increasing divergence in monetary policies, which will stoke capital outflows from Japan. Under these conditions, we see the USD/JPY reaching 122 at the end of 2017. The question in 2017 will be just how long the Bank of Japan can maintain such a monetary policy, probably so long as inflation does not pick up significantly.”