USD/JPY: caution is in order - BBH

Analysts at Brown Brothers Harriman explained that despite the rise in the US (and Europe and Australian yields compared with Japan over the past month), Japanese investors have not been significant buyers of foreign bonds.

Key Quotes:

"Drawing from the weekly MOF data, we find that four-week average in November is JPY231 bln. The four-week average in October was JPY313 bln. The average of the last four weeks in September was JPY327 bln. In August, it was JPY688 and July; Japan bought an average of JPY1.3 trillion a week in foreign bonds.    

Foreign investors have returned to Japanese equities.  In the year through November 25, foreign investors have sold an average of JPY129 bln of Japanese equities. However, over the past four weeks, foreigners have bought an average of JPY308 bln.  This is the highest four-week average in seven months. To be sure, buying Japanese shares does not mean taking on yen exposure.  The interest rate differentials (forwards) and the cross currency basis swap provide powerful incentives to hedge the long yen exposure back into dollars.  Over the past month the Nikkei is off 1.4%, but if hedged back into the dollar, the return is 8% plus the credit for the hedge.  

With the benefit of hindsight, we can see how the dollar carved out a low around JPY100.  It took three-four months to accomplish it.  Recall that the greenback peaked at almost JPY126 in early June 2015.  The rally has brought the dollar back to almost JPY115. The JPY115.60 area corresponds to the 61.8% retracement of the large down move.  

Technical indicators are beginning to flash a yellow light, suggesting caution is in order.  Perhaps a tell was that for the first time in a year, the speculators in the futures market as of last Tuesday we net short yen. The RSI and Slow Stochastics did not confirm last week's dollar highs. The bearish divergence may make momentum traders a bit cautious.  Similarly, although US 10-year yields are firm today, the technical indicators warn of consolidation or correction. The RSI and Slow Stochastics did not confirm last week's yield high, and the MACDs appear poised to turn lower. Last week, the 10-year yield approached 2.50%. The kind of correction we anticipate would push the yield a little below 2.30%."