Yenning for a catalyst
The yen has weakened significantly against most currencies recently, moving from JPY109.86 per USD on 18 February to JPY112.11 on 20 February. Beside the magnitude of the move, it is noteworthy that the yen’s decline has coincided with record highs for gold, which is sensitive to the same drivers (i.e. US rates and global uncertainty). In particular, the USD/JPY rate has diverged from what the rates differential would imply, something previously seen in early 2018.
While domestic growth is normally not a major driver of the yen’s value, the sharp contraction of GDP in Japan in Q4 (in part due to the hike in the consumption tax rate in October) and the impact on growth there of the covid-19 outbreak are having a negative impact on the yen. Of particular note is the significant underperformance of the TOPIX even as foreign investors have been moving back into Japanese equities. This leaves the TOPIX—and by extension the yen—vulnerable to renewed investor outflows. The recent decline of the euro is also most likely due to domestic financial assets’ comparative lack of appeal and punitive hedging costs. Consequently, as we cannot rule out further yen weakness in the very short term, we are adjusting our three-month projection to JPY111 per USD (compared to JPY108 previously). We are also adjusting our six-month projection to JPY109 (compared to JPY107 previously) and our 12-month one to JPY104 (compared to JPY102 previously).
However, while global risk appetite may remain resilient and further weigh on the yen, the negative impact of covid-19 on the yen may fade soon, depending on how events pan out. Indeed, either signs emerge that the outbreak outside China is being contained leads to a rebound in Asian currencies in general (including the yen), or the impact of the virus weighs even further on the global economy, in which case growing global risk aversion should lift the yen (as its use as a funding currency reverses).
In the medium term, assuming the economic impact of covid-19 on the Japanese economy is limited, we remain of the view that the ongoing moderation of the global economy (and especially of the US economy) together with higher stock market volatility should support the undervalued yen.