USDJPY likely to rise with US Treasury yields, says Morgan Stanley

The USD/JPY once again failed to break through 112.50 and it is expected to grow in line with medium-term outlook. Also, JPY short remains our preferred reflation trade, with United States fiscal and monetary policy leading to higher interest rates in the United States; the BoJ's yield curve management ensures that Japan's yields remain relatively low, noted Morgan Stanley in its research note.

The Bank of Japan (BoJ) in its November 1 monetary policy meeting mentioned its optimism over the growth of the economy, with a moderate rate of recovery observed in the global demand. The central bank is expected to maintain an easing bias, but shall not remain compelled to ease in the medium term.

We at FxWirePro foresee that the USD/JPY currency pair will test the 130 level towards the end of 2017, for the first time since April 2002. Also, the 10-year Treasury yield spread will likely widen, at over 250 basis points for the first time since 2010.

The BoJ aims at achieving the 2 percent inflation target with expectations of buying around JPY80 trillion of government bonds per year. Upward pressure on global yields since the US election could potentially mean more QE.

If Trump successfully implements his fiscal plan in its budget proposal, which is scheduled to take place on February 6, consumer inflation will surely rise, giving the Federal Reserve wider space for an interest rate hike. 

Thereby, rising Fed fund rate will increase the cost of borrowing. After the Presidential election result, JPY witnessed a massive selling against U.S. dollar, sending the USD/JPY higher by 17 percent to 118.67 in just a month’s time.

Lastly, markets now wait to watch the decision of the BoJ at its 2-day monetary policy meeting, scheduled to be held on January 30-31. We foresee that the central bank will remain committed to holding its 10-year JGB yields near zero, while keeping interest rate steady at -0.10 percent.