Credit Agricole

Sell USDJPY Idea

The biggest drivers of the USD/JPY’s rally remain the US-Japan short-term rates differential as well as the USD’s safe-haven with yield appeal. We doubt the exchange rate can continue to rely on these factors to keep driving it higher, however.

US inflation has likely peaked along with commodity price inflation. There are also signs the US economy is beginning to feel the effects of the Fed’s rate hikes thus far. Following FOMC Chair Jerome Powell’s address at Jackson Hole, we are likely passed peak Fed hawkishness. We maintain our view that the peak in the USD will be marked by the peaks in US inflation and Fed hawkishness.

We continue to expect UST yield curve inversion to act as a brake on USD/JPY’s upside as Fed overtightening risks build. The slowing in US growth in the coming quarters will lead to further UST yield curve inversion. Indeed, Fed hawkishness in the face of this slowing would feed investor concerns about Fed overtightening.

The inflation driven by the weaker JPY as well as higher food and energy prices is spilling over into broad inflation. There are two ways Japanese policymakers can address these pressures –FX intervention and/or the BoJ slightly changing tack at its September meeting.

The JPY’s safe-haven appeal will return with a slowing in global growth and as investors look for an alternative safe-haven to an overvalued USD and the EUR, which remains weighed down by the Ukraine crisis.

We recommend selling USD/JPY at 138.45with a stop-loss at 142.50 and target a decline to 130.The biggest drivers of the USD/JPY’s rally remain the US-Japan short-term rates differential as well as the USD’s safe-haven with yield appeal. We doubt this appeal can continue for the following reasons:

1.US inflation has likely peaked: our Inflation Strategist believes US headline inflation has likely peaked in Q3 and forecasts it to slow from 8.8% YoY in Q3 to6.4%YoYinQ4.Theimpact of the Fed’s rate hikes in curbing domestic demand as well as the retreat in commodity prices likely mean the peak in US inflation is behind us;

2.PassedpeakFedhawkishness:FOMCmembersareclearlyunitedinthe view the Fed has to stay the course in terms of raising rates aggressively to contain inflation and of the need to clearly communicate this message to the market. Indeed, FOMC Chair Jerome Powell’s address to the Jackson Hole Symposium removed any doubt in investors’ collective mind of the Fed’s resolve to lower inflation and we think this likely represents the peak in Fed hawkishness;

3.Overtightening risk: investors will not ignore softer US growth indicators and the growing risk of the Fed overdoing its tightening. Indeed, our US economist expects growth to slow sharply over the coming quarters and skirt recession in late 2023. Our US rates strategist expects further inversion in the UST curve and forecasts a bottom in the UST 2s10s spread of -85bp. We continue to see that Fed overtightening risk represents a brake on USD/JPY upside as well as the key to the exchange rate’s sell off;

4.Kurodaunderincreasingpressure to admit inflation is not temporary: Tokyo CPI data for July surprised to the upside and indicates acceleration in nationwide inflation as the two are highly correlated. Tokyo headline and ex- food inflation are well above the BoJ’s 2% target and accelerating and all three measures of inflation –headline, ex-food and ex-food-and-energy inflation –are already above the BoJ’s forecasts for the current fiscal year.