USD/JPY: ¥120-125 is not distant prospect – Deutsche Bank

Taisuke Tanaka Strategist at Deutsche Bank, notes that the US President Donald Trump did not offer details on income tax cuts for the middle class, corporate tax relief or infrastructure investment in his address to Congress.

Key Quotes

“The USD/JPY moved narrowly around ¥113 during the address before climbing to the mid-¥113 level after the president finished. We believe this represented an unwinding of short positions by short-term USD/JPY bearish investors with the reduced uncertainty in political events.”

“Trump said he is drawing up "historic tax reform" plans. Questions over the path toward realization of those plans, such as legislative requirements and negotiations with Congress, are likely to linger. Doubts over Trump's policies appear to have encouraged bearish forecasts for the USD/JPY. However, we believe a more realistic scenario is that tax reforms will be partially or gradually implemented over time.”

“The Fed feels a responsibility to normalize yield levels. The US economy was not notably strong at end-2015 or end-2016, but the upturn to risk-on sentiment in the markets led to a rate hike. By the same thinking, it is natural to assume that any acceleration in growth from fiscal measures would prompt a faster rate hike pace (though the Fed will have to examine carefully the feasibility of any particularly daring steps by the Trump administration).”

“We expect the Fed to raise rates twice in 2017 and four times in 2018, and believe the USD/JPY will head to ¥120-125. Skepticism has been sometimes expressed over this bullish USD/JPY forecast of ours. However, extraordinary cyclical policies could lead to an extraordinary market response. Our forecast of ¥120 in the initial stages of the Abe Market in 2013 similarly raised eyebrows but proved correct in the end.”

“Let us consider two stages. Is the USD/JPY more likely to be below-¥110 or over-¥115 in six months time? Most respondents would choose the latter as well realistic, given expectations for US rate hike. If Trump's policies are even partially realized and the Fed raises rates once by June, we assume the markets will take a positive view.”

“Most market participants would likely anticipate multiple Fed rate hikes ahead. Would we then assume that the USD/JPY would quickly peak at ¥117-118? We imagine that the majority of prognosticators would begin to talk of a rise beyond ¥120. We see bold US fiscal policy action and rate increases not as a short-term market theme but as a medium-term market driver into 2018 and beyond.”