The risk for USD/JPY is skewed to the downside: UBS

UBS FX analysts weigh in on Forex and the USD/JPY in particular: "The USDJPY fell to an intra-day low of 140.7 this week. The decline in USDJPY in recent weeks occurred against a backdrop of steadily falling US yields, which added pressure on the USDJPY to push below a key technical support level of 141.7, consequently triggering stop-loss selling in the exchange rate. Our USDJPY forecasts currently stand at 147 (Dec 24), 143 (Mar 25), 140 (Jun 25), and 138 (Sep 25). From a yield differential perspective, we note that USDJPY is now slightly undershooting 10-year real yield differentials (see Fig. 1). The latter suggest that USDJPY should be trading at around 143, rather than 141. On a short-term basis, we think the USDJPY looks oversold for several reasons and see room for a near-term bounce to a 143-147 range. First, looking at US bond yields, we think the recent decline looks overdone. US 2-year and 10-year yields now trade at 3.57% and 3.62%, respectively, versus our Dec 2024 targets of 3.75% and 3.85%. Second, the market's expectations of Fed rate cuts also looks aggressive, with interest rate futures currently pricing in 116bps of cuts by Dec 2024, versus our view of 100bps. Third, leveraged FX markets' positioning have turned net-long JPY (see Fig. 2). We think this is unsustainable; over the past 10 years, net long yen positions persisted only during periods such as 2016 and 2020, when there was persistent global risk-off sentiment or when the Fed kept its policy rate at very low levels. Notwithstanding our view for a near-term USDJPY bounce, we reiterate that USDJPY is in a medium-term downtrend and recommend investors to sell the pair on rallies. Investment implications Prospects: We favor selling USDJPY on near-term bounces towards 147. Boundaries: With the Fed commencing its rate-cutting cycle, we think 147 should be a key resistance level. Risk factors: Near-term downside risks for the USDJPY could come from a disappointing US retail sales report (due 17 Sep), or the election of a new Japan PM (due 27 Sep) who might favor faster BoJ tightening."

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