USD/JPY has been frustratingly stable but our bias is to expect it to break lower:
- The BoJ kept policy on hold last week and gave no indication that it is about to increase its asset purchases.
- Valuations are stretched. Our PPP model says that USD/JPY is overvalued by more than 20%
- Positioning and sentiment indicators show excessive pessimism towards the yen. Long Nikkei/short yen trades have made no money for investors over the past year. Investors may be losing patience with this trade and may cut their positions at the first signs of trouble. This could cause a cascading effect as stop-losses get triggered, leading to further selling.
Bottom Line: Fundamentals and technicals point to a downside break in USD/JPY. Also, as last week’s events in Ukraine/Russia highlight, global risk aversion can spike without warning. Shorting USD/JPY serves as a valuable hedge to portfolios.