We reckon from here onwards in H2 the dollar strength relies on weakness elsewhere but the ECB and BOJ are almost out of room to ease further.

Yen appreciation started amid global financial turbulence in late 2015, and this may be attributed to the currency’s traditional safe-haven properties.

There has been a shift in the effect of real rate spreads relative to nominal rate spreads on USD/JPY in the past year. Here, we estimate the impact of both nominal and real interest rate spreads on the USD/JPY exchange rate. The statistical results show that the nominal rate spread is a significant explanatory variable for the USD/JPY rate across the period examined, but they also highlight the importance of the real rate spread once Japanese rates turned consistently negative from late 2015 onwards.

Current account surpluses in Japan and the euro zone are being recycled thanks to a voracious appetite for foreign assets but that is more likely to limit EUR and JPY gains than to drive major weakness.

That leaves the threat that sluggish global growth triggers renewed capital outflows from China and a domino effect from the yuan to EM and commodity-sensitive currencies as the most likely catalyst for dollar gains from here.

The danger comes from non-oil commodities clearly, and how divergence between oil and metals prices plays out in FX will be interesting, but overall, stalling the rebound in commodities would be dollar-supportive.

We expect the dollar to make further gains in due course, but we’re not overly excited about them. There are good reasons why the dollar won’t fall much further: non-oil commodities are vulnerable, the oil bounce may not go much further for now and last but by no means least, US real yields and rates have very little downside from here.

But it’s a struggle to dream up positive reasons for the dollar to rally. Higher real rates/yields require the Fed to tighten faster than markets expect and we’re not holding our breath on that.

We recommend buying a USD/JPY 6m digital call strike 107 with a knock-in at 102. This option costs only 66%, which compares to 100% without the barrier.

Investors buying a digital barrier option cannot lose more than the premium initially invested. It would, however, expire worthless if USD/JPY does not reach 107 within the next six months, one can rest assured with gains even if it trades above the 107 strike at the expiry as we have ITM calls as well.