BCA Research: Stay short USDJPY; 1995 sell-off equivalent to Y47

Harvinder Kalirai, chief strategist at BCA, says the introduction of further monetary stimulus in the US reinforces his bearish outlook for USDJPY, given that the Bank of Japan – as has been the case since the start of the financial crisis in 2008 – is unlikely to match the expansion in the Fed’s balance sheet.

Furthermore, he says with the Fed extending its commitment to zero rates until mid-2015, interest rates will remain bearish for USDJPY.

According to BCA, since the early 1970s, USDJPY has always come under pressure when the policy rate spread of the US over Japan drops below 400 basis points.

That implies Japanese investors require a minimum 400bp of additional yield as compensation for assuming currency risk. Otherwise, the Japanese are reluctant to recycle their excess savings into overseas assets, or they choose to hedge their currency exposure.

“In light of the Fed’s announcement this week, interest-rate differentials won’t rise back above 400bp until the second half of the decade,” says Kalirai.

“Therefore, USDJPY’s cyclical bear market may yet continue for several years.”

He adds, even though USDJPY is close to its modern-day low, there is plenty of room for further downside. That is because the fair value of USDJPY has dropped dramatically during the past several years due to Japan’s modest deflation.

Kalirai points out that in 1995, USDJPY undershot purchasing power parity by almost 40%.

“An equivalent undershoot today will take USDJPY to ¥47,” he says. “This is not meant to be a forecast, but only to illustrate the still significant downside potential even from current levels.”