USD/JPY to target ¥118 by year-end – Deutsche Bank

Analysts at Deutsche Bank remain bullish on USD/JPY and target ¥118 by year-end and continue to recommend tactical buying on dips.

Key Quotes

“USD/JPY continues to be driven primarily by US rates, long-term nominal yields currently being the best predictor of FX movements. Even more strikingly, the correlation with the broad dollar has bounced back to pre-crisis levels, ending a five-year period of the yen leg dominating the cross. Our prediction of a sustained uptrend in USD/JPY thus assumes US growth of around 2.5% and two further Fed hikes in June and December. For next year, we expect 3-4 more hikes alongside balance sheet unwind. Similar to the Fed, our bullish view does not hinge on fiscal stimulus expectations, which have been priced out by now and pose little risk of further disappointment. Given very benign market pricing, this should push US ten-year yields to 2.75% by the end of the year. With the BoJ likely to continue the yield curve anchor, a 50bp widening in the spread should be worth ¥6-7 upside this year based on recent betas.”

“The trajectory will be far from smooth, though. Periods of adjustment are likely, especially in light of continuing turmoil in the US administration and lingering risks around North Korea. That said, Japanese investors should cement a firm floor by buying dips at around ¥110. Moreover, while Japanese outflows are unlikely to drive USD/JPY upside in the absence of rising US rates, recent weekly flow data suggests that Japanese buyers have already returned to foreign bond markets since the end of the fiscal year, after being reliable sellers in the first quarter.”

“Positioning has tracked USD/JPY unusually closely in recent months and is considerably lighter than at the start of the year. The main counterargument to the trade--apart from geopolitical unknowns--is valuation, with the yen still the second-cheapest currency in the world. If rising US yields attract growing Japanese outflows, however, valuation shouldn't be more than a gentle headwind.”