JPY: Slowly hastening US rate hike cycle – Deutsche Bank

According to Taisuke Tanaka, Strategist at Deutsche Bank, the USD/JPY market has gone back and forth at the low ¥110 level over the past two months, gauging the start of the Trump administration and believes this narrow range trading is nearing an end.

Key Quotes

“The markets were relieved at President Trump's undisruptive congressional address last week. Furthermore, the Fed chair has alluded clearly to the possibility of a rate hike this month. The markets have priced in an over-90% likelihood of a rate hike by the FOMC (15 March) after confirming solid payroll data this Friday.”

“Our US economists expect the Fed to raise rates in March, June and September this year and another four times (once per quarter) in 2018. In our thoughts, the primary determinant of the course of the USD/JPY is the US economy and interest rates. We expect the USD/JPY to move in line with our interest rate forecasts: it should try ¥115 with the March rate increase, solidify at ¥115-118 with the June hike, and burst through ¥120 with the September increase with discounting some additional hikes into 2018.”

“We believe investors should look harder at risk scenarios on the basis of this bullish USD/JPY outlook. First is the case that Trump's policies fall short of expectations in timing or feasibility due to negotiations with Congress or legal complications, leading to a downward revision in forecasts for the Fed's tightening pace. That said, we feel the USD/JPY will continue to be supported to varying degrees if these policies are realized even partially or later than intended.”

“The second case is a faster Fed tightening pace that pushes up the dollar, causing share prices to turn bearish. This is particularly true if the US economy does not hold up as strongly as hoped. The Trump administration may also take a more contentious stance against the Fed. Still, the president's promise of an aggressive fiscal policy has buoyed sentiment among both corporations and households. Moreover, the Fed is unlikely to raise interest rates at a tempo that would harm the stock markets.”

“A third case would be a serious threat to the Trump administration's ability to govern or remain in power. Geopolitical risk in Europe, China or elsewhere could also harm prospects for the US economy and interest rate hikes. While we cannot rule out such possibilities entirely, we do not feel that they should be treated as mainline scenarios for building positions, at least at this stage.”

“The uptrend in the USD/JPY is unlikely to be smooth and should endure occasional corrections. As seen in GPIF's December settlement, Japanese investors would support the USD/JPY at around ¥110 by dip-buying but are unlikely to be a driving force above ¥115. In the near term, if the rate fails to go beyond ¥115 if/when the Fed raises rates this month, the currency can be corrected down in disappointment. However, we stand by our view that the USD/ JPY will rise in line with US interest rates as long as the outlook for these risk scenarios remains relatively low.”