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Feb 22 - 02:55 PM

ING: JPY's Undervaluation and the Carry Trade Influence

By eFXdata  —  Feb 22 - 01:30 PM

Synopsis:

ING's analysis identifies the Japanese Yen (JPY) as significantly undervalued, estimating it to be around 15% below its medium-term fair value. Despite this undervaluation, the yen's performance continues to be negatively impacted by the prevailing carry trade dynamics, with the yen serving as a primary funding currency in 2023. This trend aligns with the general performance pattern in the G10 currencies, where currencies offering higher risk-adjusted carry, such as the Canadian dollar and the British pound, have outperformed. The yen, in contrast, has depreciated by 6% against the dollar year-to-date.

Key Insights:

  • Carry Trade Dynamics: The current market environment, characterized by low volatility and favorable conditions for carry trades, is expected to persist, keeping the JPY under pressure.
  • Valuation and Trade Balance: Despite its weak spot value, the yen's valuation is bolstered by Japan's shifting trade balance. The transition from a JPY 2.5 trillion trade deficit during the 2022 energy shock to a trade surplus supports the currency's fundamental value.
  • Future Outlook: A meaningful recovery in the JPY's value against the USD may hinge on a broader downturn in the dollar's strength, anticipated towards the end of the second quarter. Any further rise in USD/JPY to the 155/160 range would present an opportunity for corporates to adjust their hedging strategies regarding USD receivables and JPY payables.

Conclusion:

While the JPY remains significantly undervalued based on ING's fair value models, its performance continues to be influenced by the carry trade, with the yen being a favored funding currency. The change in Japan's trade balance towards a surplus underpins the yen's fundamental valuation, despite its current weakness. Looking ahead, a shift in the broad dollar trend could catalyze a correction in USD/JPY, providing a strategic point for adjustments in corporate hedging activities.

Source:
ING Research/Market Commentary

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