The yen is the worst performing G10 currency so far this year.

The yen has been under pressure for two reasons. The first is an adverse terms of trade effect from the conflict in Ukraine given Japan’s hefty reliance on imported energy. The second is the fact that the BoJ has refused to entertain the idea of tighter policy despite rising inflation, the rate hikes elsewhere and the slide in the yen.

In fact, the yen has looked like a real sitting duck when it comes to monetary policy now that 10-year JGB yields have risen to the 0.25% Bank of Japan ceiling, prompting the bank to offer unlimit ed JGB purchases at the ceiling rate. As a result, rising yields in other G10 bond markets automatically lead to wider interest rate differentials now that the 10-year JGB yield is stuck at 0.25%. With all this in mind, it might seem very obvious that the yen will plunge even further. But Mr. Steve Barrow, Head of Standard Bank G10 Strategy doesn’t think that will happen. “We expect dollar/yen to slide back to 120 over the next year”, Mr. Steve Barrow said.

This being said, a much stronger yen could be dependent on a material downturn in global economic and financial market prospects. To some extent, these trends are already in train. Stagflation risks abound and, unsurprisingly, asset prices such as bonds and stocks have plunged as investors start to position for the worst. There could be more of this pricing that needs to take place although the bulk of this could lie outside of government bonds. Instead, it is more likely to be in equities, corporate credit and more.

In short, a risk-off environment seems set not just to prevail but to accelerate, and Mr. Steve Barrow thinks this could bring a stronger yen back into play in a couple of ways.

The first is that it could limit , and possibly even reverse the sharp rise we’ve seen in commodity prices. The yen’s weakness so far this year probably relates to the hit to Japan’s terms off trade from the surge in commodity prices, particularly energy. If this starts to go into reverse it could help the yen to recover.

A second aspect is that the surge in bond yields we’ve seen in other G10 countries could peter out, or even reverse as recession fears rise and annual inflation peaks. Should yields elsewhere come down JGB yields will probably decline as well. But the moves in Japan are likely to be modest compared to elsewhere and, this too, could help the yen to rebound as rate differentials narrow.

In addition to these two key issues, there are other background factors to bear in mind that could aid the yen. One is the fact that the yen is undervalued on most metrics of ‘fair’ value. Of course, currencies don’t just go up because they are undervalued, but Mr. Steve Barrow feels it could help suck in foreign portfolio investment. The currency’s weakness could ultimately prompt a policy switch from the BoJ, probably not in terms of a rate hike but perhaps via a widening of the -0.25% to 0.25% trading range for 10-year JGBs or, more likely, a decision to switch the target to a shorter maturity, such as 5-year JGBs.

Another factor is that if the financial asset environment deteriorates, it could lead to the unwinding of yen-funding carry trades. It seems from the yen’s weakness to date that there has not been much action on this front but we suspect that this could change going forward. The bottom line in Mr. Steve Barrow’s view is that yen strength is certainly not a done deal but if investors fear a particularly difficult economic and financial market outlook ahead, they could be best served by buying the yen at these “cheap” levels.