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Undervalued Yen In Spotlight as Stock Rout Helps 2021’s Laggard - BLOOMBERG

JANUARY 25, 2022

(Bloomberg) -- The Japanese yen is finally having a moment in the sun as nervous investors battered by the equity-market selloff seek out havens. The currency’s longstanding undervaluation means it has potential to rebound further.

Options traders are looking to hedge against yen strength, based on risk reversal skews, and the headwind typically provided to the currency by higher U.S. bond yields appears to have somewhat abated. The currency has jumped about 1% so far this year on a spot basis to 114 per dollar, though it remains far weaker than it was after notching a decline of more than 10% in 2021, its worst year since 2014. And while the yen lagged the dollar on Monday as stocks took one of their biggest intraday beatings of recent times, it’s still the standout performer among Group-of-10 currencies this year.

“A lot of the negative news is now well priced into the yen at these levels,” according to Lee Hardman, a foreign exchange strategist at MUFG in London. “We might be kind of starting that process now, whereby the yen is to rebound from very low levels, even as U.S. yields have continued to hit fresh highs at the start of the year.”

The yen has long been regarded by many observers as undervalued, though that has not necessarily yet helped it to rebound. On a purchasing power parity basis, the yen is by some calculations one of the most undervalued among Group-of-10 currencies. 

The currency has received intermittent support from speculation that the Bank of Japan might at some point join the swath of central banks around the world that are lifting benchmark rates to combat inflation pressures. Such optimism has so far proven short-lived, though, with the consumer-price index showing that the nation is still struggling to pull out of its decades-long disinflationary spiral.

On the flip side of the equation is the risk that too much tightening is being priced into other currencies -- especially the dollar -- while relatively little is anticipated for Japan. Any pullback in expectations for the Federal Reserve -- which the market is currently expecting to hike four times this year -- could weigh on the dollar and see the yen supported even if the longstanding link between rate differentials and currencies reasserts itself more strongly.

“The yen is still sensitive to rates and their yields can only go up,” said Steven Englander, chief G-10 foreign-exchange strategist at Standard Chartered. “So there could be weakness in the first half as the Fed does the two hikes that we expect, but then rally well when U.S. yields disappoint.”

The average estimate of analysts surveyed by Bloomberg is for the currency to end this year around 113 per greenback, marginally stronger than its current level.

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