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Staying Positive In USDJPY Despite Near-Term Weakness

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Trump administration's failure to repeal and replace Obamacare has hurt market sentiment, triggering concerns over the feasibility of the president's pro-growth policy agenda. In the FX market, US dollar fell across the board amidst concerns that reflation trades since Trump's victory is over. The DXY index dived to a 4-month low of 98.86 on Monday before recovery. USDJPY also plunged to 110.09, lowest since November 18, 2016, before stabilizing. As we mentioned in the January report, it would not be surprising to see USDJPY correct to 110-112 in 1Q17. Therefore, the current price movement has not yet derailed our forecast although Trump's implementation ability has surprised to the downside. While it cannot be ruled out that the currency pair might break below 110 briefly, we retain the forecast that USDJPY should recover to 115 and then to 117 later this year.

Trump pulled the healthcare bill (AHCA) from the House minutes before vote, due to the lack of support, last Friday. The House healthcare vote was important, in a sense that it is the first Congressional vote on a key policy issue and it has big implication on the advancement of the wider tax reform agenda. While the government has decided to move on and focus on tax reform bills which are thought to be simpler, investors are concerned the failure of AHCA would provide less fiscal headroom for the tax plans, not to mention the divisions within Republicans. The White House aims at passing the comprehensive tax reform legislation by August, well before the 2018 mid-terms. However, the obstacles are obvious as there are limited sources of revenue to offset the proposed tax cuts, which are substantial. The border adjustment tax (BAT) proposal is another challenge.

Besides AHCA's failure, recent USD weakness has been driven by a less-hawkish-than-expected Fed. Following the March rate hike, the Fed is expected to remain on the sideline at least until June, although the market has recently priced in lower chance of such a move. The March rate hike was not unanimous with Minneapolis Fed President Neel Kashkari favoring leaving the monetary policy unchanged. The FOMC statement showed virtually no change in the macroeconomic projections and maintained three rate hikes this year in the median dot plot.

Median Dot Plots Continued to Project 3 Rate Hikes in 2017 and 2018

USD's liquidity conditions remain upbeat. USDJPY basis swap spreads showed that the cost to borrow dollars in exchange for yen reached 23.8 bps last Friday before returning to 30-ish levels. Narrowing in cross currency basis suggests reduction in hedging cost. It also signals abundance USD funding relative to JPY's, pressuring USDJPY in the near-term.

In the medium-term, we remain positive over USDJPY, or US dollar in general. The next move for the Fed is a rate hike, rather than a rate cut. Policymakers would turn more upbeat should incoming macroeconomic data remain strong. Moreover, we believe USD as well as Treasury yields would be lifted as we come closer to the next rate hike.