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FxWirePro: Sizable impacts of North Korea risk on USD/JPY ahead of Fed and BoJ

As far as the US and Japanese currencies are concerned everything will center on the imminent FOMC and BoJ meetings that are scheduled this week. The USD positive effect of the inflation data did not last long last week. USDJPY has been range-bound since the last publication of Key Currency Views on Aug. 18. It was because both dollar and Yen underperformed among G-10 currencies; JPY has declined 0.8% in trade-weighted terms.

In the near-term, the main driver of JPY would be the relevant developments in North Korea. On Sep.3, North Korea carried out the sixth nuclear test and announced that it successfully tested a hydrogen bomb designed to be mounted on its newly developed intercontinental ballistic missile (ICBM). It has been 1 year since North Korea conducted the fifth nuclear test on Sep.9, 2016, the day of its National Foundation Day.

In the last few months, North Korea has increasingly become bolder with its actions. It fired missiles 3 times in May and once in June, followed by 2 ICBM (Hwasong-14) launches in July (4th and 28th), of which both landed in Japan’s Exclusive Economic Zone (EEZ) in the Sea of Japan. Furthermore, North Korea disclosed its plan to attack Guam with intermediate-range ballistic missile (IRBM) on Aug. 9 and it successfully launched one, which landed in the Pacific Ocean, flying over Hokkaido on Aug 29th. It has fired missiles 13 times so far this year.

Although the impacts on JPY of North Korea’s actions have been limited so far, if North Korea continues to push its boundary, we cannot exclude the possibility that JPY becomes more sensitive over its actions.

USDJPY will likely be supported around 108.13, this year’s low, unless we see a further escalation of military action of North Korea. Nevertheless, if the situation deteriorates, the possibility of USDJPY breaking and falling below108.13 is likely to increase.

Meanwhile, the decline in USDJPY this week was attributable to not only JPY strength but also USD weakness. Despite no relevant development in US macro environment, expectation for Fed hikes has receded and now the FF future market does not even price in one hike by end-2018. This appears extreme and it will likely be reversed once concerns about North Korea mitigate from next week. If the market starts pricing in more Fed hikes then, it would result in higher UST yields and a rebound in USD.

Thus, we are cautious about the risk of short-term plunge in USDJPY due to escalation of North Korean developments; however, we would see a quick and robust rebound of USDJPY once the concerns clearly recede. Leaving aside the near-term concerns over North Korea, we continue to expect a gradual downward trend in USDJPY mainly because of general USD weakness. FOMC on September 20th will unlikely become a catalyst for USDJPY moves since the pair remains strongly correlated with the Fed rate hike expectation. The BoJ is expected to keep monetary policy unchanged at upcoming monetary policy meeting on September 21st. We remain comfortable with our year-end target of USDJPY at 107. Courtesy: JP Morgan

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