USD/JPY has the capacity for huge and persistent overshoots – SocGen

Kit Juckes, Chief Global FX Strategist at Société Générale, analyzes Yen’s outlook after inflation in Japan surprises to the topside.

Inflation demands BoJ action

Japan’s headline inflation fell to 2.2%, and the so-called ‘core-core’ (ex-fresh food and energy) fell to 2.2% after a third monthly increase of 0.2%. If inflation is going to settle around 2%, rather than fall all the way back to the 10-year average (just over 1%), there is no reason to delay the demise of negative interest rate and yield curve control policies. Especially given that the Yen has lost a third of its value since the start of the Covid pandemic, and USD/JPY remains close to its post-1990 high.

This pair has the capacity for huge and persistent overshoots. CFTC data suggest that under four weeks before the crucial BoJ meeting, when one of the largest US/Japanese policy divergences we have seen will probably start to unwind, futures traders remain doggedly short the Yen. Will they be proved geniuses, or fools because a change of BoJ policy direction, ahead of a likely change of Fed policy direction later this year, signals a turn in USD/JPY? We’re in the latter camp – how could we not be? What (if anything) am I missing?