Time To Sell JPY: Looking To Go Short Vs USD & EUR - Nomura

"Trading G3 currencies in the second half of this year has been treacherous so far. The euro has traded in a 1.095 to 1.137 range, which itself lies in the rough range of 1.08 to 1.15 that has been in place since early 2015. Meanwhile, USD/JPY has traded choppily in a 100 to 107 range. This has been in sharp contrast to its almost straight line decline from 120 to 100 in the first half of this year. EUR/JPY has broadly followed USD/JPY but with a smaller range.

While the recent price action of G3 FX may be off-putting, it could be signalling a change in trend - at least over the coming months. Indeed, the yen rally earlier this year was a two-standard-deviation move, which typically subsequently reverse. This could therefore be a good starting point to consider short yen trades.

Looking at the correlations among EUR/USD, USD/JPY and EUR/JPY, we find that in recent months, the yen pairs have been the most correlated suggesting that the yen is indeed the currency to focus on rather than the dollar or euro. Focusing on the yen against both the dollar and the euro also allows one not to become too dependent on to Fed hike expectations. That leaves Japanese factors to spur yen weakness. On that front the picture is promising. The Bank of Japan is likely to engage in further easing, whether a cut deeper into negative territory, the introduction of negative rates to its loan support programmes or an extension of easing guidance or some combination of this. This could happen at the 21 September meeting or the October/November meeting.

After the big disappointment of the 29 July meeting which saw little action and so resulted in rates selling off and the yen rallying, investors are much more cautious around upcoming BOJ meetings. For example, 2yr yields have essentially moved sideways in recent weeks, rather than falling at the same stage as they did ahead of the July meeting. FX positioning, meanwhile, shows leveraged funds increasing long yen positions and asset managers scaling back short yen positions into the upcoming BOJ meeting.

Finally, the behaviour of domestic Japanese investors appears to be shifting in favour of yen weakness. Japanese purchases of foreign equities, a barometer of tolerance to currency risk (and so sell yen), have increased sharply of late. The sharp widening on a cross-currency basis caused by forthcoming US money market reform and Fed hike expectations should lead to less currency hedging, which in turn implies more net selling of yen.

Therefore, we would look to sell the yen against both the dollar and the euro".

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