USD/JPY Outlook

A rift is forming between the growing number of bearish yen watchers in Tokyo and their more positive overseas counterparts.

According to analysts, the yen continues to decline to a key psychological level of 140 per dollar.

Japan’s interest rate gap with the rest of the world, higher oil prices in the import-dependent country and a resurgent dollar have already sent the currency down 17% for the year, the worst among peers in the top 10 currencies.

“A weaker yen is imminent” as the Bank of Japan continues its loose monetary policy, said Takuya Kanada, general manager of the Tokyo-based Gaitame.com Research Institute, which has a base of $142 per dollar. However, the dollar-yen pair will have room for even more gains if US interest rates rise, “with a probability of 147,” he added.

The Bears

Tsuyoshi Ueno of the NLI Research Institute said “there are no clear factors that would strengthen the yen” as BOJ Governor Haruhiko Kuroda reported that it was too early to abandon soft policy. Perpetuating the yen’s weakness is that the dollar is making new highs as investors embraced the dollar smile argument that suggests the US currency can benefit from both strong growth and economic downturns.

“There’s still room for shorting the yen,” said Ueno, who believes it’s testing 145 against the dollar. “Japan will be the only country with negative interest rates, and the yen will get tired of the strength of the US dollar.”

This opinion is shared by Tatsuhiro Iwashige of Fivestar Asset Management Co. A “realistic target” of $160 per dollar – a level last seen in 1990 – could be the yen’s future reality, according to a Tokyo-based analyst.

“The fall in the currency is justified by the difference in interest rates between Japan and the United States and the trade deficit,” Iwashige said.

Bulls

In Geneva, Pictet Wealth Management is trumpeting something completely different.

There is limited room for the spread – a key reason for the yen’s weak performance – to become even more negative in the coming months as recession risks seep in, analyst Luc Luyet wrote in a recent note.

This trend may already have begun. The gap between US and Japan’s inflation-adjusted five-year bond yields widened from a mid-June high, the dollar against the yen has yet to match the decline that has tracked the difference throughout the year.

“The worsening economic outlook should cap interest rates worldwide, potentially creating a more favorable environment for the low-yielding yen,” Luyet wrote. He sees the yen recovering from its yearly losses to return to the 120 level next year.Strategists at National Australia Bank Ltd. are also wary of extreme pessimism gripping the world’s third-largest currency.

“A jump to 145 cannot be ruled out, but the bigger the gain, the harder the fall,” Sydney-based Rodrigo Catril wrote in a note, who believes the currency could potentially fall to a low of 130 by the end of the year.

Meanwhile, there were signs in the options market that some accounts were adding positions that would benefit from a rise in the yen to 115 per dollar by the end of the year.

And with regards to the upcoming BOJ meeting, there are also signs of caution regarding a potential turnaround from politicians who could support the Japanese currency. The weekly risk reversals that cover the upcoming decision are skewed more than 2 points towards dollar rates compared to calls. This raises some concerns about the risk of rising yen in the very short term.