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Hedging against a stronger yen pre-BoJ
The Japanese yen remains offered on rising speculations that the Bank of Japan (BoJ) could lower its inflation forecasts and add further monetary stimulus at next week’s monetary policy meeting. Yet the enthusiasm among the BoJ-doves could lead to disappointment, as the BoJ may choose to hold fire, or to intervene via a softer-than-expected action, given that its manoeuvre margin has critically narrowed. Additionally, a gradually lower support from the market and the inefficient outcome in terms of growth and inflation has become an important headache for the BoJ Governor Kuroda. The BoJ is in a sensitive position today; it is nearly obliged to feed the market with additional stimulus to keep investors satisfied. Yet, the actual monetary tools are now insufficient to grant a continuation in the current unorthodox policy trend.

As of today, the BoJ is known to hold about one third of Japanese government bonds and is estimated to buy about 90% of new debt issues to keep up with its ultra-expansive monetary policy. It is also among the top ten shareholders in 90% of Nikkei 225 companies. Hence, we can argue that sooner rather than later, the BoJ will bump against physical constraints. Therefore, there is an increasing necessity to further shift toward alternative policy tools, such as ETF purchases and deeper negative rates, which are already on analysts’ watch lists. Yet, the market reaction to alternative tools has been quite discouraging so far. We remind that the latest BoJ rate cut has resulted in a near 25% appreciation in the yen against the US dollar. The IMF is also downplaying the need for a further depreciation in the yen, given that the costs of the monetary stimulus are becoming hard to justify.

While the sell-off in the yen is occurring at a reasonable pace, exporters are reported to be hedging against trend reversal risks; sell orders are presumed at the 106.50/107.00 area.

From a technical perspective, the USDJPY will remain in the bullish trend above the 104 mark (major 38.2% retracement on July rise) and could extend gains toward 107.40, the 100-day moving average, as BoJ-doves are building fresh long positions before next week’s BoJ meeting. Still, any disappointment could rapidly drag the USDJPY below the 104 mark and suggest a mid-term bearish reversal toward the 100 mark.

On a side note, the USDJPY is sustained by the recovery in US sovereign yields. The US 10-year yield bottomed at 1.3180% on July 6th before recovering to 1.60% last week. But the positive momentum is losing pace as the market gives no more than a meagre 42.6% probability for the Federal Reserve (Fed) to raise the funds rate by the end of 2016.