Take Profit On Long USD/JPY

• USD/JPY set to continue to range-trade near term.
• We book a small profit and stay sidelined for now.
• Fundamentally, we still see a higher USD/JPY on Fed and BoJ.

Strategy
As one of our FX Top Trades for 2015, we recommended buying USD/JPY for a 127.50 target on relative monetary policy and portfolio flows. So far this year, the cross has been caught in a range by the Bank of Japan’s (BoJ) very aggressive monetary easing on the one side and a significant shift in sentiment, where speculators in 13 out of 18 weeks in 2015 have reduced their bearish JPY exposure to the least bearish level under the period of ‘Abenomics’ (see Chart 1). Following last week’s price action, USD/JPY has recovered and is now back above the 120 level. According to our short-term model, USD/JPY has climbed back into overbought territory trading 1 standard deviation above the model’s estimate of 118 suggesting that further upside potential is likely to exhaust. In the very short term, the US labour market report due on Friday could be pivotal for the USD. However, our forecast for US data this week is slightly below consensus forecasting non-farm payrolls will increase 215K (consensus estimate is 225K). If we are right, market’s reaction is likely to be modest while it probably would require a major positive surprise to trigger a long-lasting USD rally. Consequently, we have decided to close our long position and book a total profit of 0.76%.

Fundamentals
We still expect the Fed to hike interest rates in September following a recovery in US macro data which we expect to unfold in the coming months. We expect the US money market curve to steepen substantially around the first Fed hike which given the high correlation between USD/JPY and US interest rates, should support a renewed rally (see Chart 2). We do not expect the Bank of Japan (BoJ) to expand its QE programme further as inflation seems to be bottoming, wage growth is picking up and as there is no imminent political pressure for more easing. However, the recent weakness in Japanese data has indeed increased the likelihood of another policy response from the BoJ which represents an upside risk factor to our forecast. All in all, we see little prospect USD/JPY will break above its current range in the very near term as US data might still continue to disappoint this week. Fundamentally, we remain bullish on USD/JPY driven by relative monetary policy targeting 125 in 6M and we will consider to re-enter the trade in the event of a new correction lower.