USDJPY is likely to enter a tradable counter-trend rally.
Owning JGBs has never been so unattractive, both on an absolute level and from a risk-adjusted perspective.
Meanwhile, should the US data improve as we expect, but the Fed remain on the sidelines, this will likely manifest itself through the back end of the US yield curve.
Such dynamics are likely to draw capital into the United States from Japan.
The previous USD uptrend was driven by repatriation flows triggered by falling returns on investment globally. Hence, the USD rallied mostly against EM currencies.
The next leg of the USD rally should find its catalyst in rising US rate expectations. This we believe will show up against low-yielding DM currencies first and then spread into EM.
The EUR has held up better than suggested by rate differentials. Decreased FX hedging on European shares as well as potential reserve diversification into EUR are the reasons.
Once the transitory effect of short-term flows wanes, the EUR is likely to come under selling pressure again.
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