Japan: What could trigger the yen to appreciate further?

As the global risk aversion intensified in the first week of 2019, the Yen rapidly appreciated reaching USDJPY=104 although back to 109 more recently. Such appreciation has hurt economic growth in Japan through lower exports and has made the Bank of Japan’s (BoJ) role even more difficult in terms of achieving its ultimate goal of 2% inflation. Furthermore, falling JGB yields have flattened the slope of the yield curve, squeezing banks’ profit margins even further. These developments have increased pressure on BoJ to react, which has important implications for the Yen. Our view is that the BoJ will be on standby waiting for a potential technical recession after the consumption tax is hiked in October, keeping a 0% target on the 10 year JGB yield but with a looser range. With this policy stance, the Yen could appreciate closer to USDJPY=100 as global bond yields might fall more than JGB yield. This is particularly the case if global risk aversion intensifies. We believe that the BoJ is unlikely to lower the 0% target on JGB further because it requires an additional cut of the policy rate to keep the current slope of the yield curve. In other words, it seems unlikely that the BoJ may want to push the yield curve further down into negative territory as its ammunition is increasingly scarce. Such favorable interest rate differential should push the yen further towards appreciation.