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The Yen weakened notably through February after the Q4 GDP print highlighted the hit to Japanese activity on the back of the global slowdown. Since the beginning of March, USD/JPY has essentially been ‘stable’ in the high 90s, bucking the trend in the rest of the region which has strengthened against the Dollar over the past two months. So the story has been one of Yen underperforming its regional peers.

Some analysts have been bearish on the Yen for several months on the back of two key factors. First, given that the Japanese economy has suffered the sharpest contraction of all the major economies, easier financial conditions would help shape a Japanese recovery. One way of achieving that is through a weaker Yen which would be a particularly powerful catalyst for a recovery given Japan’s orientation towards the external sector.

Second, Japan’s external balance has become a negative factor for the Yen. The current account surplus has deteriorated sharply due to the collapse in Japan’s trade surplus. Continued Japanese buying of foreign assets, which has shown no let up as we crossed into a new fiscal year, is likely to keep Japan’s broad balance of payments (current account +net FDI + net portfolio flows) in deficit.

These factors still point in the direction of a weaker Yen. That said, stretched short Yen positioning is potentially a barrier to further Yen weakness. Rate differentials have long been a powerful indicator for the Yen and they give differing signals. Short rates up to the 2-year maturity suggest that USD/JPY should be lower, however longer dated differentials – namely 5 and 10-yr swaps suggest Yen spot is about right.

One important part of Yen bearish stance is valuation. Valuation models find the right price for USD/JPY to be 112.4. It is tough to see the Yen maintaining the current degree of overvaluation in the face of Japan’s current macro challenges. However, a wash out in positioning may be required to give USD/JPY the room to sustainably move above 100.