JPY: Safety First

JPY: Safety First

We are constructive on JPY over the course of 2012, believing that its natural properties as a safe haven currency will allow steady appreciation with minimal intervention risk. However, over the longer term, we believe that JPY will depreciate as investors seek higher returns abroad. We target USD/JPY at 72 by end-2012 and 81 by end-2013.

With the largest current account surplus in the G10 largely driven by capital flows, JPY naturally benefits from an uncertain global growth environment as Japan-based investors repatriate overseas investments, providing a natural bid for JPY. We believe that the global recovery remains brittle and uncertain – even as headline risk for disorderly EMU break-up has diminished in recent weeks, projected mild recession within the eurozone and below-trend growth in the US ought to keep investment opportunities limited. The reduction in net savings abroad creates a safe haven flow for JPY, which also benefits from its status as a liquid reserve currency. A related source of JPY strength is the projected global low yield environment. With the Fed predicting record low rates to mid-2014 in its most recent set of economic projections and expected to embark on a third round of quantitative easing in 2012, while the ECB is expected to cut rates and introduce QE on top of the currently in place ‘easing by demand’ three-year LTRO program, the lack of yield differential support ought to keep USDJPY and EURJPY under pressure, in our view.

The possibility of intervention to curb JPY strength poses a near-term, temporary risk to our forecast, but we believe that intervention cannot meaningfully alter the path of JPY as long as it remains one-off and unilateral. Judging from its historical behavior, we believe that the BoJ will find it difficult to justify intervention if JPY strengthening is gradual, especially if other AXJ currencies appreciate alongside JPY, as predicted in our forecasts. Recent criticism from G10 peers for intervention, for example in the US Treasury’s semi-annual report on currencies, keeps the chance of multilateral efforts to curb JPY strength off the table.

Further out, in 2013, as we expect tail risk of an EMU break-up scenario to dissipate and global growth prospects to pick up again, we believe that JPY will roll back on some of its risk-aversion-related gains as domestic investors seek higher yields abroad.