This big story in the FX market today is the news that Cyprus effectively avoided the worst-case scenario of a default and forced exit out of the euro by reaching a deal with the Eurogroup. While investors responded very positively to the news in Asia and early Europe, the gains in the EUR/USD have turned into losses at the start of the North American session. The pullback wasn’t caused by any contradictory news flow, which is always worrisome because it suggests that investors are not confident that the deal has eliminated the near term risks for Europe. Banks in Cyprus are still closed and capital controls could remain in place “indefinitely” according to government officials. While we feel that the losses in the EUR/USD should be limited because this is the best deal the market could have hoped for, contagion concerns and risk aversion remain for the time being. Yet when the tensions in Europe begin to subside, FX traders will begin to shift their focus to fundamentals and one of the currency pairs we are watching carefully is USD/JPY, which could be vulnerable for losses.

#1 Japan Fiscal Year End

March 31st marks the end of the Fiscal Year in Japan and this means is repatriation. Japanese companies have a history of repatriating money from their subsidiaries abroad to window dress their balance sheets in the last 2 weeks of March and traditionally this has been positive for the Yen. The recent strength of the Yen suggests that repatriation has already begin and could continue into the coming week. Repatriation flows alone won’t cause a massive rally in the Yen but it could be enough to drive USD/JPY down to 94.

#2 Disappointing Introductory Comments from BoJ Governor Kuroda

Last week’s press conference by Bank of Japan Governor Kuroda and his 2 new deputies was their chance to impress. Unfortunately instead of affirming their commitment to bold and aggressive easing, Kuroda sounded non-committal and unconvincing which sent the Yen soaring. This disappointment led investors to believe that there will be no emergency meeting before the scheduled announcement on April 4th and weakened the chance of easing at the first BoJ meeting to 50-50. The new BoJ Governor proved to be more thoughtful and could choose to take his time to thoroughly understand Japan’s monetary policy options before taking action. Kuroda left all options open by saying “We have to implement more effective monetary easing, but we’ll think about what at the policy board meeting.” While there is no question the BoJ will increase asset purchases next month, with a week and a half to go before the next monetary policy meeting, we expect to see consolidation and profit taking in the Yen before that happens. Also considering the amount of speculation and positioning that has built up in anticipation of additional easing, the new central bank may need to over deliver to avoid disappointment. We still expect USD/JPY to hit 100, we do not preclude a pullback to 93.25, the 50 day SMA and then possibly 91.15 (Feb lows) before that happens.

#3 U.S. Yields May Remain Under Pressure

The rally in the Nikkei overnight and the decline in U.S. 10 year bond futures (rise in yields) have been supportive of USD/JPY this morning but the pullback in the euro suggests that concerns in the financial markets have not been completely lifted by the Cyprus deal. Italy still does not have a Prime Minister and Washington is gearing up for its next big battle on the debt ceiling. The U.S. government is expected to reach the limit on May 19th and while funds could be moved around to pay near term obligations, the ceiling will need to be increased in the summer to avoid a default. As shown in the chart below, USD/JPY has maintained a tight correlation with U.S. 10 year bond yields if yields continue to fall as a result of weaker data tomorrow, we could see a deeper correction in USD/JPY. U.S. consumer confidence numbers are scheduled for release and given the sharp decline reported by the University of Michigan Consumer Sentiment index, we anticipate a deep pullback in the Conference Board’s report.

So while we do not believe that the uptrend in USD/JPY is completely over, the pair could be vulnerable to a near term correction before new highs are seen.

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