The back-up in US long-end yields over the past few weeks has put the brakes on what had been a slow but steady downward trend in USDJPY through end-2020.
JPY to partially regain its popularity as funding currency vs. the USD with rising US yields
Source: Bloomberg, Bank of Singapore
The world of ‘risk on, lower USD’ should still broadly prevail in 2021 with the exception of the USD against JPY given its high sensitivity to US yield move.
A risk-friendly environment of rising equities and commodities along with rising US Treasury yields generally means a higher USDJPY. Rising US yields have recently lifted USDJPY higher with greater reliability than falling yields dragged USDJPY lower, potentially reflecting onshore investors’ opportunistic buying of unhedged US Treasury when yields rise.
We turn neutral on USDJPY, flatlining our 3,6 and 12-month forecasts to 103. This is a change from our previous view anticipating an extension of grind down in USDJPY into 2021.
Last year saw a risk rally undermining the USD’s safe haven status more than the JPY’s as 10-year US Treasury yields stayed well below 1%. But with fiscal optimism in the wake of the Georgia runoff pushing US yields above 1%, we could be entering a new phase where JPY could partially regain its popularity as a funding currency vis-à-vis the USD amid a still improving global growth outlook.
We expect 10-year US Treasury yields to reach 1.50% over the next year. But we do not think the Fed will induce a further sharp sell-off in Treasury bonds by cutting its asset purchases suddenly this year.
The Bank of Japan’s (BoJ) policy review due in March 2021, which may affect ETF or Japanese Government Bond (JGB) buying operations, is unlikely to result in any game-changing actions for the JPY.
There is speculation that the (implicit) +/-20bp range of 10-year JGB yield target around 0% will be widened, but we are not sure what good such a policy move would do given that that actual yields have been trading well within this range.
It is also not clear that the balance of payment pressures will still be tilted towards JPY buying in 2021 as was the case last year.
The picture on portfolio flows for the JPY is mixed. A return to foreign bond buying given the attraction of higher yields could work against a slowing of bond outflows by the Government Pension Investment Fund (GPIF).
Despite improvement in flows into Japanese equities, the potential lift to JPY could be somewhat neutralised by hedging operations by foreign investors with a FX-neutral strategy.
On the other hand, higher commodity prices, especially oil, could undercut Japan’s trade surplus, although the drag on the current account could be offset by a potential resumption in tourism-related services exports in the latter part of 2021.
Outward mergers and acquisitions (M&A) halved in 2020 with deteriorating business sentiment due to the Covid-19 crisis. But as the world recovers, outward M&A investment could rebound in 2021 to the detriment of the JPY.Disclaimer applicable to recommendation
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