Citibank: Why USD/JPY could drop to 115 by Milan Cutkovic


Bottom line: The liquidation of USD longs will pressure USDJPY further. There is risk for the pair to test the December low around 115.5 by the end of April given benign market expectations.
The first and main reason we are wary of yen strength is the improvement in Japan’s international account. The current account is now recovering to the level before the 2011 earthquake. The recent drop in oil and commodity prices is accelerating the improvement via shrinking imports and narrowing the trade deficit. Long-term momentum of USDJPY like the monthly RSI tends to follow the current account balance with a one year time lag. Given the improvement over the last year, it looks like yen weakening momentum may wane.

The second reason is overseas investments by Japanese investors. Pension funds and other long-term investors are viewed to be active again these several months after subdued foreign asset purchases in Q4 2014. We suspect the public funds are facing a dilemma that they need to increase foreign asset holdings to meet the new asset allocation typically shown in the government-led GPIF reform while Abe’s government no longer seeks yen weakness this year. Japanese politicians and policy makers even be displeased with a weaker yen if it comes before the nationwide local elections and the climax of TPP negotiations this spring. There is still need to shift portfolios over time, but we suspect they will probably slow activities again while EURJPY and other crosses are stopping declining more recently.

Thirdly, M&A announcements by Japanese companies, which suddenly swelled in January and February, have shrunk and are normalizing this month. This was a background force for yen depreciation in February and early March. The announcements totaled more than USD 20bn in February. Following the more recent normalization however, the downward pressure on the Japanese currency will likely lessen.

We still expect long-term USD appreciation and believe the trend rise in USDJPY hasn’t stopped yet. However, perceived declines in prospects for imminent Fed tightening is capping yields and is seemingly prompting liquidations of USD longs. We don’t think JPY shorts among short-term investors are large at present, and in this case as the fear for the Fed’s tightening eases and it improves the risk appetites among investors a large downside for USDJPY below 118 cannot be expected. Considering the improvement of Japan’s balance of payments (the larger current account surplus, peaking outward portfolio investments and smaller FDIs), the general softness in USD will likely trigger a modest further decline in USDJPY.

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