Implied volatility on the Japanese yen has been surging in recent weeks following BoJ dovish comments last month. Not only the BoJ has not expressed any interest in normalizing its policy despite the surge in inflation globally, the central bank recently offered to buy an unlimited amount of 10Y JGBs at 0.25% to limit the upside retracement in LT bond yields. As a result, the strong divergence in monetary policy between BoJ and other DM central banks (particularly the Fed) has led to a significant rise in USDJPY.
USDJPY broke above its 125.80 resistance (the high reached in 2015) to reach a high at 129.37 on Tuesday, and is now the worst performing currency among the DM world, down over 10% against the greenback since the start of the year.
JPY is now the most undervalued currency among the G10 world, currently trading 21.3% below its ‘fundamental’ value, which is estimated based on a BEER FX model using the terms of trade, interest rate and inflation differentials as explanatory variables.
Even though the yen appears as a ‘cheap’ currency to buy at the moment, MP divergence could continue to weigh on JPY in the near term. In the past cycle, the last two bullish trends on USDJPY driven by strong MP divergence saw an upward retracement of 20 to 25 figures. Hence, USDJPY could increase to at least 135 (start of the trend at 115), which represents a strong resistance (135 was the high reached in February 2002).
Figure 1: G10 FX Spot Rates vs. ‘Fair’ Value