USD/JPY Rebounds On US Yields, Oil Price Rise, BoJ Expectations; What's Next? - Analysis

Dollar-yen rose Wednesday above Y109 for the first time since closing below that mark nearly a week ago.

The pair has been underpinned by firming U.S. Treasury yields, as well as the feel-good effect from rising oil prices, which now is taken to mean improved global growth.

Whether the pair can maintain a toehold over Y109 and retest the psychological Y110 level in coming sessions will depend on how various dominos line up going forward, traders said.

Dollar-yen was trading near Y109.25 in afternoon action, on the high side of a Y108.51 to Y109.41 range.

From the most recent high of Y113.80, seen March 29 to the most recent low of Y107.63, posted April 11, which were the lowest levels since Oct. 31, 2014, dollar-yen has fallen 5.4%.

This would likely be deemed a too fast-paced move in too short of a time by the Bank of Japan and indeed subsequently, Japanese officials have tried to jawbone the yen lower.

Dollar-yen's recovery, from last week's lows, has been driven by a modest push higher in U.S. Treasury yields, where ten-year yields have moved from 1.687% to today's highs near 1.797%, and a run-up in oil prices to new 2016 highs, also today.

Osamu Takashima, G10 strategist at CitiFX, pointed out the April 17 Doha meeting of OPEC and non-OPEC members could have ramifications for the yen.

"If the oil producers fail to freeze production levels, another swing to risk aversion in financial markets could depress USDJPY to the recent low around 108 or even below," he said.

"The pair's latest advance, if continued, has to be reinforced by a further recovery in oil prices and market sentiment, which will be realized only if the oil producers reach an agreement," Takashima added.

As background, in recent sessions, as West Texas Intermediate rallied from $35.26, seen April 4) to Y$42.42 today, just as dollar-yen rose from Y107.63 to Y109.41.

"A return of oil prices to the $50-60 range will be required for a sustainable risk appetite recovery and therefore it should be a crucial factor for the medium-term outlook in USDJPY," CitiFX's Takashima said.

From a technical perspective, the "critical focus stays on the Y108.00/Y106.45 support zone," said Niall O'Connor, technical analyst at JP Morgan.

"This area represents the swing target from the 2015 cycle peak, the range measured move from the same high, as well as dual retracements from the 2014 low and the 2011 cycle low" and therefore may be a "tough support areas to break from a short-term perspective, especially given the oversold framework," he said.

On the topside, "last week's breakdown area and former range lows near Y110.67 highlights the first important hurdle to reassert the short term upside bias," O'Connor said.

An upside break above that level "should allow for a retracement back to the Y113.80/Y114.90 resistance zone which represents the 38.2% retracement from the November peak, as well as the mid-February to mid-March range highs," he said.

Credit Suisse strategists have changed their three-month USDJPY forecast for the first time since Feb. 9, with the forecast now at Y105 versus Y110 prior. Their 12-month forecast remained at Y105.

The strategists offered myriad reasons for why the yen may strengthen in the near-term.

First, "the bar to BOJ intervention is very high" and "it is unclear that further BOJ easing would materially weaken the yen," they said.

On the government and monetary policy front, "potential fiscal accommodation removes the urgency to add to existing monetary stimulus," the strategists said.

With two G7 meetings in May, Prime Minister Shinzo Abe is "unlikely to waste political capital by re-engaging in 'currency wars,'" they said.

G7 finance ministers and central bank governors will meet May 20-21 in Sendai City, with their discussions setting the tone for the G7 Summit May 26-27 in Ise-Shima.

Credit Suisse reminded also that Japan upper house elections (and potentially lower house also) will take place in July and that "'Abenomics' are proving unpopular amongst the public."

Also, the greenback overall has been on the defensive "not helped by continued downward revisions to US Q1 GDP, they said.

Finally, Japanese investors bought overseas assets in January and February, the strategists said.

"This creates potential for repatriation pressures if 'risk off' price action were to re-emerge in May," CS added

Offering an alternative view, Valentin Marinov, head of G10 research at Credit Agricole-CIB, saw three reasons for why the recent uptrend in yen may be reversing, pointing to "FX valuation, BOJ QE3, and FX flows"

On valuation, "the latest JPY rally partly reflected excessive undervaluation fears," which have "abated considerably" subsequently.

BOJ uncertainty has been another favor, with global investors wondering if the central bank "can deliver a credible policy to boost inflation and growth."

CA-CIB looked for the BOJ "to announce stock-market purchases on 28 April and boost money supply growth in the quarters to come" which "should lower the long-term fair value of JPY and encourage a fresh round of selling."

Aggressive BOJ easing, or so called QE3, "could push USD/JPY up by at least four big figures," he said.

Analysts continued to discuss investor flows, both in and out of Japan, which have been a clear driver for the yen in recent months.

Ministry of Finance weekly transaction data, released April 7, showed that Japanese investors sold Y50.1 billion in foreign stocks, bought a net Y65.1 billion in foreign money market instruments, but more importantly, sold Y1.5551 trillion ($14.3 billion) in overseas bonds for the week ending April 1.

Last week on the bond front, for positions ending March 25, Japanese investors bought a net Y1.1641trn ($10.7 billion) in foreign bonds.

As a reminder, in the week ending March 18, Japanese investors bought a net Y2.3 trillion ($21.2 billion) in overseas bonds, the strongest ever recorded and on the back of several weeks of other hefty foreign bond purchases.

Analysts have kept a close eye on the MOF flows for confirmation that Japanese investors might again begin to eye domestic assets more favorably.

In prior years, after fiscal year-end March 31, Japanese investors typically looked abroad again in search of better results, with some of these outflows already evident in April.

The most recent MOF weekly transaction data will be released Thursday.

For yen, Japanese government bond and stock direction, much will hinge on what the BOJ does at the conclusion of the April 27-28 meeting.

In a recent BOJ Insight piece, MNI's Hiroshi Inoue that the central bank faces mounting pressure to "consider additional easing following the drop in corporate inflation expectations and slower-than-expected improvement of the output gap, with data on households' inflation expectations disappointing as well."

BOJ Governor Haruhiko Kuroda has stated that the BOJ will examine risks to economic activity and prices and take additional easy policy, if needed, in terms of three dimensions - quantity, quality and the interest rate.

"However, the imposition of the negative interest rate policy has generated a lot of criticism, making it difficult for the BOJ to further lower the negative rate from -0.1%," Inoue said.

"Possible options at the next meeting, should the BOJ decide to move, are to increase purchases of Japanese government bonds and ETFs (exchange traded funds)," he added.

Any increase in BOJ equity purchases may be of special interest to global investors.

BOA Merrill Lynch's monthly fund survey, taken April 1 to April 7 and released Tuesday, showed that "investors are underweight Japan equities for the first time since December 2012." .

A net 3% of fund managers were underweight Japanese stocks in April, versus a net 15% overweight in March and a net 24% overweight in February, the survey said.