Dollar-Yen Upside Nears Limits: BBH

Tokyo CPI undershot estimates on Friday, which weighed on JPY. Image © Adobe Images.

The dollar's rally against the yen is nearing its limits, says Brown Brothers Harriman.

The FX specialist says the dollar-to-yen exchange rate (USD/JPY) is running ahead of fundamentals, and a move above the key 150 level looks unlikely at this stage.

However, the call comes as USD/JPY extends its run of gains, pushing higher by 1.22% this week, having been as low as 140 in April. The move takes it to the cusp of the psychologically significant 150 level at the time of writing Friday.

Further upside impetus was offered to the exchange rate by a relatively soft Japanese inflation print, that draws some question marks as to whether the Bank of Japan can raise interest rates again before year-end.

"USD/JPY is trading near important psychological resistance at 150.00," says Elias Haddad, Senior Markets Strategist at Brown Brothers Harriman. "Tokyo September CPI printed weaker than anticipated."

Headline and core CPI inflation remained at 2.5% y/y last month, disappointing a consensus for both readings to read at 2.8%.

However, Haddad explains the softness is largely down to transitory factors, in particular the Tokyo government’s move to broaden access to free daycare.

BBH's assessment is that inflation is still trending in a direction that will warrant higher interest rates in Japan.

"We are sticking to our view that the BOJ will resume normalising rates in October," says Haddad.

Currently, markets see the outcome at 55% odds, suggesting ample scope for a repricing in favour of further rate hikes and associated JPY strength.

Indeed, Japan’s Tankan business survey points to an ongoing recovery in real GDP growth and underlying inflation is making good progress towards the BOJ’s 2% target.

"Bottom line: we doubt USD/JPY can sustain a break above 150.00 given that it’s already trading well-above the level implied by US-Japan 2-year bond yield spreads," says Haddad.

Last week, the Bank of Japan opted for the status quo and left its policy rate at 0.5%, while domestic core inflation stayed elevated above 3.0% in August.

However, in a surprise to market watchers, two policy members voted to lift the policy rate to 0.75%, versus seven in favour of keeping rates unchanged, signalling that the Bank stands ready to raise interest rates again soon.

"The dissents will certainly help reinforce expectations that the BoJ could decide to lift the key rate at the next meeting in October," says Derek Halpenny, Head of Research for Global Markets EMEA at MUFG Bank LTD.