The nominal yield spread between the US and Japan is set to widen further with the Fed likely to raise rates for the second time in either June or July, thus providing support for USD/JPY.
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However, the opposing force of Japan’s rapidly expanding current account surplus likely means the upside for USD/JPY will be limited.
Japan recorded a Q1 surplus of 4.6% of GDP, approaching record levels. The Abe administration has been clear in its opposition to yen strength although the G-7 finance ministers’ meeting in Japan revealed opposition to intervention by Japan.
But ultimately the yen is set to remain broadly underpinned by the substantial turnaround in Japan’s external position. Trade data for April revealed that Japan’s trade surplus widened more than expected, to a seasonally adjusted JPY 426.6bn, the largest surplus since February 2011. The turnaround in just 12mths has been dramatic – the 12mth deficit to April was JPY 200bn versus a deficit of JPY 8.36trn in the 12mths to April 2015. Risk aversion will need to ease on a sustained basis in order to see the yen weaken given the rapid expansion of the overall current account surplus, which in Q1 reached 4.6% of GDP.
We have adjusted our USD/JPY forecast levels to reflect the jump in May and the potential for the Fed to hike in June or July, but we continue to expect the yen to remain well supported. Our end-2016 USD/JPY forecast is 104.00.