(Bloomberg) -- The barriers preventing the yen from reaching 100 per dollar, a target that has proved elusive for the past two years, are dropping one by one.
An escalation of the U.S.-China trade war took the haven asset through 110 in mid May. Next to go was resistance at 108.50, which crumbled late last month when President Donald Trump threatened to put a 5% duty on Mexican imports. The threshold of 105 now looks vulnerable as U.S.-Iran tensions worsen and investors await a planned meeting between Trump and Chinese counterpart Xi Jinping at this week’s Group-of-20 summit.
“What’s come out fresh over the past week as a catalyst to push dollar-yen toward 100 is the geopolitical risk over Iran,” said Daisuke Karakama, chief market economist at Mizuho Bank Ltd. in Tokyo. “If war breaks out in the worst case, that would typically push the dollar lower.”
Leveraged funds swung to a net long position on the yen this month for the first time in a year as the U.S.-China trade war boosted haven assets. At the same time, the dollar fell as traders priced in Federal Reserve interest-rate cuts. The yen has strengthened about 4.6% from this year’s low set in April, advancing to 106.78 on Tuesday when Iran said new U.S. sanctions meant the path to a diplomatic solution was closed.
The yen is particularly sensitive to geopolitical news, and may break through the 105 level “in the coming days and weeks” if Iran or China tensions escalate, said Jane Foley, head of currency strategy at Rabobank International in London.
Next Hurdle
If the yen strengthens beyond 105, the next hurdle is likely to be 104.87, the high set during January’s yen flash crash, and then the psychological level of 103.
Getting to 103 will probably hinge on a Fed rate cut, according to Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co. in Tokyo. “As expectations for U.S. rate cuts have accelerated amid concern the U.S. stance on trade negotiations is much tougher than previously thought, our forecast for dollar-yen has had to be move lower,” he said.
The yen has typically tracked the rate differential between Treasuries and Japanese government bonds, strengthening as the spread narrows. As expectations have grown that the Fed will cut rates, the extra yield on 10-year Treasuries over similar-maturity JGBs has dropped by almost a percentage point from a November high.
Overnight swap markets are pricing in three Fed rate cuts this year, with the first expected as soon as July. The timing is right to lower rates preemptively, Fed Bank of St. Louis President James Bullard said in St. Louis Tuesday. At the same time, Bullard, who votes on monetary policy this year, played down the need for a 50-basis-point cut.
In order for the yen to strengthen to 100, Treasury yields would need to extend their decline and the Bank of Japan would have to cut its policy rate further to minus 0.2%, JPMorgan’s Sasaki said. “The 10-year U.S. yield needs to be around 1% for dollar-yen to touch 100,” he said.
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