USD/JPY, CAD/JPY, CHF/JPY flows: JPY starting its big reocvery

The big JPY rise overnight has come on the back of comments from BoJ governor Ueda, even though on the face of them they don't really alter the prospects for BoJ policy tightening near term. Nevertheless, the detailing of an exit strategy from ultra-easy monetary policy, including a discussion on how much to raise the policy rate when the decision is taken to exit, has triggered a sharp rise in the JOY and JGB yields. JGB yields had slipped lower in recent days alongside similar declines elsewhere and indications from BoJ officials that no change in policy was likely in December, but the comments from Ueda are a reminder that Japan is on a different cycle to the rest of the world, and tightening is likely in 2024 while others are likely to ease.

The JPY was already at low levels relative to yield spreads even before Ueda's comments, but spreads have moved significantly further in its favour in response. We remain big JPY bulls for the longer term, mainly from a value perspective, as the real JPY decline in recent years has sent it to its lowest level in the floating era against the major currencies. But in the shorter term it has been driven by nominal yield spreads, and the decline in these should be the trigger for a big correction. Correlations with yield spreads are strongest in USD/JPY and CAD/JPY, which both look to have scope for declines of another 3% or more from here just based on the nominal yield spread correlation. The biggest long term misvaluation looks to be CHF/JPY, which has risen around 50% in the last two years, but 10 year Swiss/Japanese yield spreads now favour Japan for the first time since January 2022, when CHF/JPY was trading around 125 – a 25% drop from current levels. While the market reaction to Ueda may be overdone in the short term, and JPY gains may stall ahead of the US employment report tomorrow, the long term picture looks very JPY positive.