Global Risks Put Yen at Top of Pile for 2019 Currency Forecasts
Japanese yen and U.S. dollar banknotes are arranged for a photograph in Tokyo, Japan. (Photographer: Keith Bedford/Bloomberg)

Global Risks Put Yen at Top of Pile for 2019 Currency Forecasts

(Bloomberg) -- The myriad of global risks this year is keeping yen bulls happy and encouraging bets on a world-beating rally in coming months.

The Japanese currency is predicted to outperform its Group-of-10 peers by the end of 2019 and gain nearly 3% to 105 per dollar, according to Bloomberg’s survey of currency analysts. With the bullish tone also reflected in the options market, Morgan Stanley and BNP Paribas SA expect tense geopolitics to drive it to a three-year high of 100 by early next year.

Global Risks Put Yen at Top of Pile for 2019 Currency Forecasts

“The global environment is in what we describe as an ‘unstable equilibrium’ and we think this is going to cause volatility and a setback in risk assets,” said Hans Redeker, the global head of currency strategy at Morgan Stanley. “All that is going to lead to yen strength.”

The yen is only lagging the Canadian dollar in gains against the greenback this year, as growing trade conflicts drive investors into havens. While large Japanese bond redemptions in coming months could act as a transient drag on the currency, the Bank of Japan isn’t seen having the firepower to curb its ascent as global peers ease policy faster.

Morgan Stanley is among the most bullish, predicting the yen to rally more than 6% from current levels to end 2019 at 101 per dollar, while BNP Paribas predicts 102. Options traders are also betting on gains. Three-month dollar-yen risk reversals, a gauge of options sentiment and positioning, are at 182 basis points in favor of yen calls, more than average this year.

Allianz Global Investors’ Mike Riddell is one fund manager overweight the yen, which he sees as “an excellent portfolio diversifier.”

“The risk of a global recession in the next 12-18 months is greater than 50-50,” said Riddell, whose firm oversees 543 billion euros ($594 billion). “Within our funds, we think ‘what is going to be your risk-off hedge’. This is where you really need to have some currencies -- things like the Japanese yen will have a very large rally in a crisis and or a global recession.”

Bond Flows

There is some caution among analysts given seasonal trends that often mean the currency weakens into the end of the year. The yen has slipped this month to trade around 108 per dollar.

With 24.3 trillion yen ($226 billion) of Japanese government bonds due to mature during the rest of 2019, much of this money is expected to be reinvested in assets overseas, leading to selling of the yen.

“While redemptions do impact the yen, you have to think about how international development will look in the first quarter of 2020,” London-based Redeker said. “Is this going to be an environment where investments are looking good, where you will reallocate it abroad, or is it an environment where potentially volatility is coming into the market.”

The policy outlook at the Bank of Japan is another doubt, given the prospect that it could ramp up stimulus in October after standing pat this month. A strong yen could hamper the BOJ’s efforts to reach its inflation goal by pushing down prices for imports. Yen money markets are pricing a 10 basis points rate cut from the BOJ by the end of 2019, with a second cut by the end of 2020.

Still, the BOJ looks like the most constrained Group-of-10 central bank for BNP Paribas SA’s European head of currency research Sam Lynton-Brown, certainly compared to the Federal Reserve’s rate-cutting cycle. Japanese policy rates are already negative and the central bank’s high bond ownership means it has even less space for asset purchases than the European Central Bank.

“We think the BOJ are unlikely to use up any of their limited ammunition currently,” said Lynton-Brown. “On quantitative easing they already own 45% of the domestic bond market and their easing program has been going on for longer than elsewhere in the world, which mechanically means they have less room to do more. The yen should outperform as the BOJ struggles to match easing elsewhere in the world.”

Global Risks Put Yen at Top of Pile for 2019 Currency Forecasts

If Fed easing continues to drive 10-year U.S. Treasury yields below 1%, that could send the yen surging to 90 per dollar, according to RBC Capital Markets. However, more limited easing and elevated Japanese hedging costs for overseas assets could instead weaken the yen, said chief currency strategist Adam Cole.

Ultimately domestic factors will be dwarfed by the global outlook for BNP’s Lynton-Brown, given the risk of a deterioration in the U.S.-China trade relationship and also between the U.S. and the European Union.

“This would weigh on global risk sentiment, global equity markets, causing an appreciation in the yen,” he said.

©2019 Bloomberg L.P.

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