“Substantial Volatility” Ahead: One Bank’s Take On Yen-Sanity

Well it’s all about USDJPY on Monday.

Of course if you’ve traded these markets professionally for any length of time, you know that it’s pretty much always about USDJPY.

But in the current environment the pair has taken on a special role as a running referendum on the market’s faith in the Trump trade or, more accurately, the reflation narrative. I’ve talked about this at length over the past couple of months.

Last week’s meeting between Japanese PM Shinzo Abe and Donald Trump was a potential land mine for markets. Some feared that, given the new administration’s efforts to crack down on and target countries that pursue a weaker currency, Trump might throw markets for a loop by putting additional pressure on the BoJ to refrain from sticking to yield curve control. Indeed, there was quite a bit of speculation that the recent confusion around Kuroda’s commitment to anchor JGB 10s was directly related to internal discussions at the BoJ regarding the extent to which intervening to cap 10Y yields would be seen as proof that Japan’s monetary policy was targeting a weaker yen.

Considering that Monday’s narrative is centered around USDJPY I think the following commentary out this morning from Deutsche Bank is particularly apt.

Via Deutsche Bank

Nevertheless, the summit has undoubtedly reduced concerns about politically triggered yen appreciation to an extent. We now expect US fiscal and monetary policy expectations to firm up downside support for USD/JPY in the near term. Fed Chair Yellen is set to testify before the Upper and Lower Houses on Tuesday and Wednesday this week. Markets are likely to look for clues about whether the next rate hike will come in March or June. However, while US economic momentum continues to trend upward, the biggest accelerating factor will be fiscal policy. We think Yellen will avoid giving a clear signal on the next hike at this point, while maintaining the possibility of three hikes this year.

We see firmer near-term downside support for USD/JPY within the 110-115 range, shifting to 115-120 within 3-6 months as US fiscal and monetary policy advances. If the full range of promised fiscal policies is introduced over the next 1-2 years we would see this as consistent with a USD/JPY of 120-125, but this range would be highly sensitive to political developments. The Japanese government could verbally intervene to slow yen depreciation if USD/JPY showed signs of breaking above 115-120.

We think the focus for USD/JPY in the 3-6 months following the US/Japan summit will be US fiscal and monetary policy. However, this period could also see multiple overlapping issues that trigger market jitters, including elections in Europe, Middle Eastern tensions over the US embassy in Israel, relationships between the US/UK (+ Japan) vs. Europe at the G7, and US vs. China at the G20. At the least, we envisage substantial volatility rather than a smooth uptrend in USD/JPY.

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