Nomura forecasts a drop in the USD/JPY exchange rate, expecting it to decline from 144.92 to 136 by the end of September. This prediction is influenced by Japanese investors bringing funds back home and potential pressure from Washington for Tokyo to strengthen the yen. If the Bank of Japan takes a more aggressive stance, local yields could rise. This might lead domestic investors to prefer local bonds over foreign ones. MUFG offers a slightly different forecast, estimating that the USD/JPY might reach 138.30. Both reports hint at a possible change in exchange rates due to various economic factors. Major players in the market are indicating downward pressure on the USD/JPY over the medium term, with targets in the high 130s. Nomura highlights two important reasons for this expected change, both related to how domestic capital behaves and international diplomatic relations. The first reason involves Japanese investors moving funds. As interest rates between countries start to equalize, the incentive to keep foreign assets decreases. When these funds come back home — usually by selling foreign currencies to buy yen — it creates steady demand for the yen. This process builds momentum over time. The second reason, which may have a stronger immediate impact, is external pressure. If the dollar-yen rate approaches long-term highs, it could become a political issue. If Washington expresses concerns about a strong dollar, it might create obstacles for this currency pair. Meanwhile, the Bank of Japan has suggested it might adjust its monetary policy. If domestic yields rise even slightly, Japanese institutions may be more inclined to invest in local bonds. This is particularly relevant for pension funds and insurers that seek yield without currency risk. MUFG has a less pessimistic estimate, but both forecasts agree that the yen is undervalued due to domestic changes and external factors. The difference lies in timing and the extent of adjustment. From our viewpoint, the combination of these factors calls for a shift in strategy. With spot levels near 145, there is significant potential for a decline. Implied volatilities are stable, making it a good time to establish short delta positions. Keep an eye on longer-dated JGBs, as they may signal shifts in capital flows. It’s not just about current spot levels. The forward curve hasn’t fully accounted for the potential adjustments. The gap between current values and institutional forecasts could widen if risk aversion increases or interest in cross-border investments decreases. We should closely monitor spreads between local and foreign bonds. Although cross-currency basis swaps are stabilizing, any widening could indicate larger capital flows. Options structures can be adjusted to benefit from a weakening dollar against the yen. Risk-reversals currently favor yen strength, supporting this strategy. Premiums are mostly balanced, providing an opportunity for layered entries through the end of Q3. Overall, the current setup suggests it’s time to rebalance positions that have been too focused on dollar strength this year. Although we aren’t at a point where long yen positions are widely accepted, sharp rebounds often start in these quieter moments. Keep an eye on short-term yield differences and any shifts in policy commentary. The trend of one-sided trades seems to be diminishing. We will adjust our strategies accordingly.

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