Opinions

In two of our recent opinion pieces in Aug, we had detailed why the winds of change for JPY was imminent. Yen has rallied by about 3% over the course of a couple trading days, likely in part due to the rising probability of domestic policy shifts that could meaningfully strengthen the Yen, as well as the higher perceived risk of intervention following a possible “rate check” on September 2. We believe that a faster pace of BoJ hikes or signs of rotation back towards Japanese assets could keep the Yen stronger for longer even without a shift in the global macro backdrop. We will be watching the International Transactions in Securities (ITS) data for August, which offers investor-level detail on foreign asset flows, will be released on September 7 for any clues in change to inward flows. Taking both macros & flows in to account, the case to be tactically long JPY has strengthened (despite the risk of some pullback after a sharp move). But the clearer improvement in asymmetry over a longer horizon now makes short USD/JPY a more attractive hedge for pro-risk portfolios than it has been in a long time. The overarching point for us is that Japanese policymakers appear to be focused on pulling the available levers to attract capital inflows, and there is plenty of capacity to conduct additional interventions to further reduce JPY short positioning along the way. We believe there may be a fairly sizeable JPY short position that was built up after the launch of the Takaichi administration in October last year, amid concerns over the administration’s economic policies. Our estimates suggest JPY shorts amount to ¥16–17 trillion, and if this position were to be fully unwound, USD/JPY could fall to the 142–146 range. GPIF is the elephant in the room. The fact that a report on basic portfolio verification was presented at the 21st August Management Committee, can be viewed as an early sign of a potential basic portfolio change. Our estimates suggest GPIF may have been a net buyer of foreign bonds by about ¥0.9 trillion and a net seller of foreign equities by about ¥1.7 trillion. A large deviation from these estimates could serve as a signal that GPIF’s portfolio is changing. Hence the monthly flow data on 7th Sep becomes more important to understand the flow dynamics. We also estimate that even without a basic portfolio change, if GPIF were to raise the weight of yen assets (domestic equities and bonds) toward the upper end of the current range, it could generate JPY buying / foreign-currency selling flows of more than ¥30 trillion at maximum. By contrast, if GPIF were to change the basic portfolio and raise the share of yen denominated assets, it could not only generate even larger JPY-buying / foreign-currency selling flows, but the announcement effect could also trigger a significant short-covering rally in the JPY. To summarise, with US treasury intervention and Bessent’s recent remarks that BOJ has to take decisive monetary steps to combat JPY weakness, Sep hike is a done deal for BOJ. What matters now is the forward guidance and the terminal rate discussions. From a flow perspective, prospective GPIF reallocation towards domestic assets could be the game changer for JPY fortune. We remain bullish on JPY and our base case is JPY ending CY26 around 152 levels. Best case could be 145 by end CY26 and worst case around 155 by end CY26. CMP is 156.26

We believe coordinated US-Japan currency intervention marks a turning point and are making a significant revision to our BoJ policy outlook. We had assumed the BoJ would limit itself to gradual rate hikes of once every six months to align with the dovish Takaichi administration, and that the terminal rate would remain below the neutral rate at 1.5%. However, we now believe the coordinated intervention has effectively freed the BoJ from the constraints imposed by the administration, enabling it to pursue a more aggressive rate hike path. Accordingly, we are bringing forward our next rate hike forecast from December to September, and we expect the BoJ to continue hiking in Dec’26, June’27, and December’27, with the policy rate reaching 2% by the end of next year. The risk of more aggressive hikes remains, depending on Fed policy. Our new main scenario (60% probability) assumes four rate hikes, in September 2026, Dec’26, June’27 & Dec’27. In what we see as the more likely risk scenario A (25% probability), we assume rate hikes in September 2026, December 2026, March 2027, and June 2027 in view of the increased risk of higher-than-expected inflation as a result of yen depreciation. Together with our main scenario, this gives a probability of 85% for a rate hike in September 2026. In our less likely risk scenario B (15% probability), we assume only two rate hikes in October 2026 and Mar’27. Going forward, the primary focus will be on how quickly the BoJ can proceed with rate hikes—without causing significant damage to the real economy or equity markets—in order to contain excessive yen depreciation and upside inflation risks. BOJ's outlook for next year is heavily dependent on Fed policy. Our view is that the Fed is likely to be on hold for a long time with the next rate action a cut than a hike, but should the Fed enter a rate hike cycle contrary to our forecasts the BoJ could be compelled to adopt a faster pace of hikes (e.g., once every three months) and the terminal rate could exceed 2%. To summarise, BOJ is likely to focus on JPY depreciation led inflation and respond hiking by 50 bps in REMCY26. Terminal rate now looks 2% rather than the previous 1.5% estimates. Takaichi administration & US treasury together will force BOJ to leave it’s dovish stance & focus on real interest rates which are deeply -ve.

The Japanese and U.S. authorities conducted a coordinated FX intervention on 31 July. Both governments have acknowledged that the intervention was carried out. While the amount of yen buying by the US may be limited, the signalling effect of this rare, coordinated intervention is significant. We see the recent joint action as showing strong commitment from both sides. The fact that the operation was coordinated suggests that extensive currency diplomacy took place beforehand. The shift to coordinated intervention with the United States raises expectations for a broader policy framework aimed at stabilizing the yen. This is in interest of US as a rapidly depreciating JPY was aiding Japanese exports, pulling JGB yields higher & pushing long end UST yields higher along with it. If MoF Japan had intervened on it's own, they will have to sell USTs further pushing UST yields higher. By coming to MoF's rescue, US treasury has defended not only long end UST yields but also ensured Japan does not indiscrimately sell USTs to support it's fx operations. A coordinated intervention effectively blurs the ceiling associated with unilateral currency intervention. In addition, Treasury Secretary Bessent has encouraged the use of the Foreign and International Monetary Authorities (FIMA) Repo Facility, while Finance Minister Katayama has also stated that Japan intends to make use of the facility. The degree to which both governments have presented a united front is notable, both in emphasizing the potential firepower behind Japan's yen-buying intervention and in limiting any adverse impact on the U.S. Treasury market. Considering this joint intervention, we believe stars are now aligned for BOJ to hike in Oct’26 and Mar’27. We believe Fed might be on hold for REMCY26 and hence we view JPY likely to test 155 now more than 160. Our bullish view on JPY needs to be validated by BOJ hiking in Oct. We now see test of 155 levels of JPY imminent and a breach below this level might accelerate inwards flows from life insurance and exporters. The stop to the above view is BOJ delaying hike beyond Oct or JPY breaching 160 on a weekly basis. Our CY26 end target for JPY is now 152. CMP is 157.76.

US Job gains slowed to 57k in June (Our estimate: 75k, Consensus: 113k), along with 74k of negative revisions to the prior two months. The deceleration was largely driven by negative payback after unsustainable strength in past months. Beyond the monthly noise, underlying employment growth remains solid. While the weaker US June NFP report (+57K vs. consensus +113K) led USD lower (at least initially), we believe it may still be a little early to call this the start of a USD downtrend. The forces that have combined to strengthen the Dollar over the last few months look increasingly likely to endure. We remain most bearish on JPY and then GBP. We remain neutral on EUR and bullish on CNH.

Global macro-outlook has turned +ve for Dollar. USD is benefitting from: 1. Carry/ Terms of Trade 2. A more balanced Fed 3. Firmer domestic data 4. Renewed US equity strength. Shifting terms of trade have dictated FX returns in recent months. These ToT shifts should lead to diverging growth outcomes, which have started to become clearer in recent activity data, including the sharp downside surprise in China April activity data and the deceleration in the May flash PMIs for Europe. While there are a number of important exceptions, like CNY and commodity-intensive exporters, the net effect of the AI boom and higher-for-longer energy prices leaves the US looking like a relative outperformer once again. Also the situation in the Middle East which is not mending itself as many would have assumed a month or so ago. Signs that the Hormuz strait will stay clogged for longer can only exert upward pressure on oil prices – with the dollar gaining 0.5-1% per 10% of higher oil prices in our estimates. From the perspective of US macros itself. the US labor market is showing more signs of demand stabilization after months of softness weighed heavily on the USD. US inflation upside surprises are re-emerging, challenging expectations of limited pass-through to core inflation. US equities are in the midst of one of their great ~2m runs ever reinvigorating the notion of dollar-positive US exceptionalism via strength in the tech sector. USD OIS curve is still meaningfully lower than the G10 average. This could narrow two ways - by 1) depricing RoW hikes, or 2) if US rates continue to creep higher on growth/inflation/Fed signalling. On Euro itself, we’ve a bearish-EUR/USD forecast & now expect a range of 1.12-14 in H2CY26. The Euro is among the lowest yielders globally, growth momentum has substantially worsened vs the US, relative ToT deteriorated sharply. The real yield differential has narrowed further, completely reversing the improvement post-German fiscal u-turn in March 2025. On JPY, we remain bearish and believe if not for intervention, JPY might have breached the crucial 162 levels. On GBP too, we remain bearish & see 1.30 levels sooner than later considering last week’s set of poor data & continued political uncertainty. Only AUD & CNH might remain insulated from DXY strength as AUD gets supported by commodity strength & CNH has a high current account surplus supporting it’s resilience. To summarise, we now see DXY moving towards 102 levels in H2CY26 if 98 holds on the downside. DXY is currently at 99.25.

USD/JPY finally breached 158 to the upside last week, closing at 158.74. There was no strong evidence of MOF’s interventions around 158. We believe market interventions can only delay the inevitable as FX fundamentals have not yet tilted toward USD/JPY downside because: 1) Oil remains elevated, leading to the rise in USD. 2) There are no strong signs of Japanese investors’ repatriation. 3) Japanese fiscal policy uncertainty increases, owing to news reports on the supplementary budget. Bessent might not want any UST redemptions from MoF in the current rising US bond yield environemnt, hence the support for JPY intervention. But crude remains elevated with brent closing 109+ last week. We estimate a potential maximum impact of JPY 6trn deterioration in Japan's trade deficit if Brent remains around 105-110. This amounts to a 5-6% depreciation in JPY. Even on capital flows, while equity inflows remains strong, bond outflows continue to remain elevated resulting in a net neutral picture on flows. JGB yields continue to soar with 30yr JGB above 4% (first since 1999) finding no love from local lifers. While we see June hike as very likely, the bar for BOJ to outhawk current market pricing is very high. For e.g. the 2yr forward 1yr swap rate which can be viewed as one proxy for the terminal rate — has already risen above 2%. This is above the midpoint of the BOJ's estimated neutral rate range in nominal terms, and depending on the estimate used, is already in restrictive territory. But it is unlikely that hiking to such levels represents the consensus view among BOJ Policy Board members. Furthermore, market skepticism regarding coordination between the government and the BOJ is likely to persist, which will likely weigh on the JPY. In summary, we believe JPY might remain headed towards 162. Any intervention is unlikely to make it rise above 156 levels. To break above 162, JPY needs 10yr UST around 4.85 & Brent above 120. On the upside 156 is the level below which JPY can sustain only if BOJ turns distinctly hawkish or Brent falls below 90. But with DXY finding strength last week, we expect a retest of 162 before 156.