USD/JPY: 110.00 on a 3 mth view - Rabobank

Analysts at Rabobank explained that the reflationary spirit that has taken hold of the US bond markets has injected a large amount of potency back into the BoJ’s monetary policy settings. 

Key Quotes:

"As we have frequently pointed out the mighty US yield curve has had a huge impact on the transmission mechanism of several other central banks this year. In the first 9 months of 2016 US yields were trending lower and dragging down the value of the USD with them. Against the weight of the soft USD, central banks such as the BoJ, ECB, RBA and RBNZ were unable to undermine the value of their respective currencies vs. the greenback despite the announcement of fresh policy stimulus. The recovery in US yields started in October and the recent surge in their values and the USD can be associated with a significant loosening of the monetary conditions in several other economies due to exchange rate movements.

The loosening in monetary conditions implied by the exchange rate will be a welcome relief to the BoJ. Last night the release of Japanese national CPI data for October confirmed a very weak inflationary backdrop. The core index at -0.4% y/y continued to display deflationary pressures, though the headline inflation number rose by a modest 0.1% m/m. Widespread scepticism in Japan about the ability of Japan to meet its 2% CPI inflation is likely to have a negative influence on forthcoming wage negotiations in Japan. In previous years the BoJ and government have pressured large companies to boosts wage deals in an effort to strengthen demand but these effort have clearly not been successful in turning around inflation expectations.

Following a rise in concern about the side-effects of policies such as negative interest rates and QE, the BoJ in September announced a different tact. The BoJ currently aims to keep the 10 year JGB yield at 0%. Domestic bank shares rallied on the announcement on the expectations that a steeper yield curve would offer their business models relief. 

However, this policy is unprecedented and there has been some concern as to how the BoJ would react to the upward drag on international bond yields caused by the movement in US treasuries. On November 17 the BoJ concluded a special fixed rate bond buying operation for the first time to reassert its commitment to it QE programme and fire a warning short against expectations of excessive moves in JGB yields. This commitment suggests that as long as the market believes in the reflationary power of the President-elect that the spread between US and JGB yields will widen and USD/JPY can fly higher. 

In our view, however, the market may be over-anticipating the reflationary prospects of the USD and both treasury yields and the USD could correct lower medium-term. While we have recently moved up our forecasts for USD/JPY, our expectation for a correction lower in US treasuries leads us to the conclusion that USD/JPY will also correct lower in the medium-term. Consequently we are forecasting a move back to 110.00 on a 3 mth view."