While the USD has appreciated broadly against the major currencies during Q1 2010, it has failed to appreciate against the JPY, and USD/JPY has been relatively stable. The weaker-than-expected U.S. economic figures earlier this year, particularly housing and labor market statistics, and the consequent expected delay of Fed fund rate hikes were deterrents to buy USD/JPY. The pair was pushed down further in early March, when there was a widespread concern about the potentially large repatriation of foreign profits by Japanese firms ahead of the March 31 Japanese fiscal year-end.
But by late March, sentiment towards the JPY definitely turned bearish. The USD/JPY trading range shifted upward rapidly as Japanese investors increased their demand for foreign investment just before the start of the fiscal new year. Outward investment intensified into the new year. The USD started this week by hitting a seven-month peak near 95 JPY.
Over the past several weeks, the JPY has broken below key medium-term supports on the non-USD crosses such as AUD/JPY and CAD/JPY, and the CFTC data shows that net positions in the JPY flipped from long to short in the week of March 30. This data suggests a resumption in the popularity of JPY-funded carry trades where investors sell JPY to buy high-yielding currencies such as AUD and CAD.
Optimism in USD/JPY was also set off by speculation that the Fed may soon hike the discount rate based on recent stronger U.S. data. A report released on Monday showing the economy's vast services sector grew last month at its fastest pace since mid-2006 added to optimism sparked by last Friday's payrolls report, which showed employers added jobs in March at the fastest pace in three years.
The USD/JPY upward move has been swift lately, leading to skepticism that further strength can be sustainable in the near future. Unless the Fed unexpectedly signals an earlier shift to policy tightening in this week's release of the March FOMC meeting minutes, the USD/JPY could give back its recent gains and correct lower in the short term. However, JPY bearish factors are building momentum which can cause USD/JPY to rise further in the medium term.
One of the drivers in the advance of USD/JPY is the higher U.S. yields. A rise above 4 percent in the 10-year U.S. Treasury note yield for the first time since June has helped the USD by making USD-denominated Treasuries more attractive than comparable but lower-yielding Japanese government bonds. USD yields will likely outstrip that of the JPY as the U.S. recovery regains momentum in the coming months. By contrast, the Bank of Japan is expected to maintain further easing as deflation is expected to remain negative for the rest of this year and 2011. By making a clear commitment to continue easy monetary policy for longer than currently expected, the Japanese government bond (JGB) yields will be compressed and discourage the JPY bulls.
Recent JPY selling by the Japanese institutional investors has pushed the USD/PY higher. More overseas investment in the coming months will lend the USD/JPY further support. In addition, outflows related to the M&A activities from the corporate sector could weigh on JPY on a broader basis. In its own survey, the Nikkei daily newspaper reported last week that 61 percent of the 28 major Japanese food and daily goods firms are considering mergers and acquisitions. While Japan is the primary area of focus in terms of target destination, the survey shows that firms are also looking overseas for acquisitions, in particular East Asia and Southeast Asia. Faced with an aging population and persistent deflation, Japanese domestic demand is unlikely to show significant long-term growth, which prompts Japanese firms to consider overseas investments, resulting in a broader basis in JPY selling pressure.
Though the recent rise of USD/JPY looks stretched and may incur a correction in the short term, JPY weakness has broader support. Taking into consideration the recent resilient price action showing limited downside risk for both USD/JPY and U.S. yields, USD/JPY will have further upward potential towards 100.
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