There are three reasons why the recent JPY uptrend may be turning: FX valuation, BoJ QE3 and FX flows. Here, we focus on the first two factors while FX flows will be discussed in a subsequent report.
The latest JPY rally partly reflected excessive undervaluation fears. These concerns have abated considerably, however, with USD/JPY now trading closer to its ‘fair value’ implied by purchasing power parity or our long-term valuation model.
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Another support for JPY remains investors’ scepticism that the BoJ can deliver a credible policy to boost inflation and growth. We expect the BoJ to announce stock-market purchases on 28 April and boost money supply growth in the quarters to come. This should lower the long-term fair value of JPY and encourage a fresh round of selling.
The results from our model simulation further suggest that, under fairly conservative assumptions about the 2Y USD-JPY rate spread, 10Y USTJGB bond yield spreads and the Nikkei, aggressive BoJ QE3 could push USD/JPY up by at least 4 big figures.