JPY guide 2018 (2) US interest rates

From: Deutsche-Bank

USD/JPY likely to repeatedly test highs in 115-120 next year amid rising US rates

We forecast US economic growth of 2.6% in 2018 and expect the Fed to raise rates once this month and another four times next year. The USD/JPY is likely to test upside in line with medium/long-term interest rate trends for the time being. However, wages and the inflation rate are not rising much and medium/ long-term interest rate increases have also been limited in the current economic
cycle. Sluggishness in US medium/long-term interest rate increases implies lack of momentum in USD/JPY buying linked to this trend.

We cannot rule out the possibility of a modest rise in US medium/long-term rates on signs of stronger wages and inflation if the US economy sustains growth above a cruising pace with full employment throughout 2018. In that case, US rate hike expectations are likely to strengthen and this should also bolster upward momentum in the USD/JPY. We also think expectations that the yen will weaken will grow somewhat against a backdrop of wider discrepancy in Japanese and US short-term interest rates after the Fed hikes multiple times.

From a yield curve perspective, we anticipate a gradual rise in medium/long-term interest rates as policy rate hikes spur higher short-term rates. In the past, the USD/PY has tended to rise in the process of such bear flattening of the yield curve.
Disparity between Japanese and US interest rates normally explains the USD/JPY. With Japanese rates remaining unchanged at very low levels for a prolongedperiod, however, the US interest rate trend itself largely explained the USD/JPY.

In recent years, the difference in real interest rates calculated using Japanese and US expected inflation rates appears to be doing a good job of explaining the USD/JPY. Nevertheless, the extreme USD/JPY movement since Abenomics has strongly affected Japan’s expected inflation rate and it should be noted that the difference in real interest rates follows the USD/JPY in some cases. We think US nominal interest rates provide a much simpler and more effective signal in reading the USD/JPY.

(To be continued)

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