From a historical PPP valuation perspective, the Japanese Yen remains a very cheap currency.
The Japanese economy is also exhibiting many of the characteristics of having a cheap currency as the trade balance is improving rapidly (although admittedly this is more a price than a volume story) and the current account surplus is likely to reach ~5% of GDP by the end of this year.
However, momentum in Japanese growth is poor; inflation expectations are inconsistent with the BoJ’s 2% inflation target; the Nikkei is a relative laggard YTD and the 2020 nominal GDP target of 600 trillion Yen looks out of reach. Against this background, markets have moved over recent months to discount an increased risk of ‘Abenomics’ failure and the Japanese Yen is the strongest performing G10 currency YTD (up ~11% vs the USD).
The unchanged decision by the Bank of Japan (BoJ) this week was therefore a surprise and the hesitant nature of the BoJ’s easing of late will embolden views by segments of the market that the BoJ is running out of ammunition. For the Japanese Yen, there is also the added complication that US Treasury officials have indicated that overt attempts by the Japanese authorities to weaken the Yen would be unwelcome.
The Federal Reserve meanwhile remains very cautious in its policy normalisation cycle and is providing very little support for the US dollar at present whilst the US economy, in general, continues to underwhelm. This suggests that in the near-term the path of least resistance in USDJPY could still be lower, in part because lower terminal US rate expectations have the potential to trigger a change in hedging behaviour of Japanese investors (i.e. they increase their hedge ratios on foreign assets of which a significant proportion are held in US dollars).
However, should the US economy regain some momentum in H2 2016, there remains the prospect of one further Fed rate hike this year. More importantly, we believe that it is too soon to expect Abe/Kuroda to throw in the towel on their efforts to reinvigorate the Japanese economy and we expect further monetary easing and fiscal stimulus over the summer months to support growth and the stock market. These efforts should serve to slow any decline in USDJPY, but a material move higher will require an upswing in US growth allowing a more sustained hiking cycle by the Fed and aggressive easing efforts by the Japanese authorities.