Danske Bank anticipates that the Bank of Japan (BoJ) is likely to tweak its Yield Curve Control (YCC) policy before implementing conventional rate hikes, according to its recent report. The bank proposes two ways this could happen: widening the YCC band to ±100bp from the current ±50bp, or shortening the target maturity of the YCC policy from 10 years to 2 or 5 years. Both methods would effectively tighten monetary policy. Danske Bank expects the BoJ to make these changes at one of the upcoming meetings, with the July or September meetings being the most likely.
Other factors likely to impact the JPY include improving external balances, with the Japanese trade balance and terms of trade rebounding from historically low levels. The tourism sector also appears to be recovering, which could add some JPY demand to the market.
In terms of positioning, speculators are nearly stretched short in JPY. Risks to this outlook include a rally in global commodity prices, which would present an upside risk to the USD/JPY as Japan is a net energy importer. Moreover, upward moves in US yields could continue to be a tailwind for the USD/JPY.
In conclusion, Danske Bank believes the USD/JPY seems fundamentally overvalued and, combined with potential monetary policy tightening, expects the cross to drop below 130 within a 6-12 month horizon