Japanese Yen Outlook

1 - 3 Month Outlook 

USD/JPY reversal As markets turned risk-averse and currencies reverted to their traditional status as safe-haven or risky asset, JPY was the star performer through Q3, rising against all G10 currencies. However, the evidence now suggests JPY is being propped up by increasingly skewed positioning and for the first time since the beginning of the Abe/Kuroda era, FX managers appear to be short USD/JPY. Having previously persistently profited from USD/JPY rising, since June managers appear to be losing money when USD/JY rallies and vice versa. On the face of it, this is compelling evidence that FX managers have a large concentration of risk in short USD/JPY positions. Other measures of JPY positioning have shown a similar pattern in recent weeks. CFTC net short JPY positions, having accounted for 70-80% of open interest for most of the last three years have slumped to just 10-20% in recent weeks. Similarly, having been consistently bid for calls, USD/JPY risk reversals have flipped to be bid for puts across the entire vol curve. Of course, just because the market appears to be short USD/JPY, it does not follow that spot has to trade higher. But the establishment of a sizeable long JPY position outside Japan helps explain why persistently negative capital flows have not weakened the currency recently. With those flows ongoing and positioning extreme, the balance of risk favours a reversal of USD/JPY losses Q4. 

6 - 12 Month Outlook

Weaker on capital outflows The capital outflows referred to above have much further to run. Contrary to the widespread view that the GPIF reallocation is "close to completion" many more months of outflows are seen. Although the Q2 allocation into foreign stocks was the biggest ever, price action in Q3 more than reversed it. Having put JPY2.5trn into foreign stocks in Q2, mark-to-market losses have cut holdings by JPY3.0trn in Q3, leaving GPIF with another JPY6trn to buy. And this does not include other public pension funds that follow GPIF and will only start reallocating this month (JPY30trn of assets in total) or a similar reallocation by soon-to-be privatised Yucho and Kampo. And private sector investors are expected to start selling JPY (via lower hedge ratios) as US rates start to rise. Overall, the case for USD/JPY trading much higher in the long-term remains compelling.