FX Trading focus: JPY over a cliff, getting overdone. UMich sentiment in the spotlight
USDJPY has continued to soar almost without a hitch, with the 114.50 next major chart resistance swinging into view all at once on the backdrop of soaring commodities prices (Japan totally reliant on commodities imports, particularly so in energy) and despite US long treasury yields that have suddenly been tamed this week. That requires other supportive factors for JPY bears, including the commodities issue noted above, strong risk sentiment, rising yields at least at the front of yield curves if not at the long end, but possibly also due to the political shift here. Namely, Prime Minister Fumio Kishida is sending out signals that he will seek to reduce inequality and spoke out rather strongly against the neoliberalism of Abenomics. This is a currency negative development at the margin, although a capital gain tax proposal has already disappeared after it was floated recently and cratered Japanese equity markets.
So how low can the JPY go? It is within two percent of the very cheapest level, on a broad CPI-adjusted real effective basis, as shown in the chart below. I suspect it will only firm up on some combination of global credit markets beginning to deteriorate, global yield curves suggesting a recession over the horizon (too early), and importantly, if and when the burst higher in commodities is reversed. By the way, I find the simultaneous rallies in commodities, particularly in energy, and equity markets/risk sentiment entirely incompatible in the medium term. Surging energy prices are often at the root of recessions and we are getting there with the recent price rises if these persist much longer.
Chart: USDJPY vs. JPY REER
The real-effective CPI-adjusted JPY rate is getting toward an historic low (inverted on chart below) as USDJPY soars into the major 114.50 area that capped the action for much of 2017 and 2018. Remember that due to lower inflation in Japan relative to the US, that the “fair value” exchange rate crawls lower over time as long as that remains the case, such that 115 today is similar to 125 back in the 2015 time frame. USDJPY has long history of finding big round numbers sticky psychologically – interesting to see if 115.00 proves similar this time around.