Yen's Rising Linkage With Yield Differentials Signals Upside

(Bloomberg) -- A strengthening link between the dollar-yen exchange rate and the U.S.-Japan yield differential augurs well for the Asian currency, with a number of strategists predicting it will extend its recent rally.

The correlation between the two variables climbed to 0.63 this month, the highest in a year, data compiled by Bloomberg show, as the benchmark 10-year U.S. yield hit a one-year low amid Federal Reserve Chair Jerome Powell’s signal to pause policy tightening. Standard Chartered Plc, Citigroup Inc., Bank of America Merrill Lynch and HSBC Holdings Plc are all expecting a stronger yen in the months ahead.

“We were looking for a catalyst to be short dollar, and I think we have finally got that in the form of the dovish Fed,’’ Mayank Mishra, a macro strategist at Standard Chartered in Singapore, said in an interview on Bloomberg Television. “Short dollar-yen is one of our highest conviction calls in G-10 FX right now.”

Yen's Rising Linkage With Yield Differentials Signals Upside

Standard Chartered expects the dollar-yen rate to drop to 105 by the year-end, with the risk skewed toward the downside, Mishra said. That points to a decline of about 4 percent from a level of 109.53 as of 6:15 p.m. in Tokyo on Friday.

Citi, which views the Japanese currency as being “very cheap,” is predicting an even steeper rally to 103 over 12 months. Its previous projection was 108.

“Akin to 2018, dollar-yen remains a yield play,” Citi strategists including Jeremy Hale wrote in a note. “Macro conditions warrant a further decline in 10-year U.S. Treasury yields.”

The yield premium offered by 10-year Treasury debt over similar-maturity Japanese bonds shrunk to as little as 256 basis points on Jan. 3, the day the yen jumped to a nine-month high of 104.87 per dollar in a flash crash. The spread was 312 basis points in November, the widest in 11 years.

Yen's Rising Linkage With Yield Differentials Signals Upside

BofAML also lifted its yen forecasts and sees the currency testing 100 this year, strategists including Shusuke Yamada wrote in a note Thursday. Slowing purchases of overseas assets in the past few months demonstrate a potential shift among Japanese investors to risk reduction from dip-buying as the global economy may have peaked, the strategists wrote.

Japan’s currency outperformed all of its Group-of-10 peers and rallied 3.7 percent against the dollar in the last quarter of 2018. While MSCI’s All Country World Index of equities slumped the most since 2011 over those three months, the Swiss franc -- another traditional haven currency -- ended the period little changed.

HSBC forecasts the yen will appreciate to 105 per dollar in the fourth quarter of this year. The Swiss National Bank’s measures to cap strength in the Swiss franc means the Asian currency will be the beneficiary of safe-haven flows, according to David Bloom, HSBC’s global head of foreign exchange strategy.

“One of the reasons that the yen moved so violently previously is that the idea that you can buy the Swiss franc as a safe haven is disappearing, which puts more pressure on the yen,” Bloom said in an interview Friday.

READ: Counter view -- Dollar-yen to march to 115

©2019 Bloomberg L.P.