Analysis-Steep oil and sunken yields flash more weakness for Japan’s

By Kevin Buckland and Alun John

TOKYO (Reuters) – A jump in the price of oil and a yawning gap between yields at home and those of U.S. bonds have left Japan’s yen with next to no chance of a quick recovery from the symbolic 120 level it fell to Tuesday, analysts say.

The yen breached 120 per dollar for the first time in six years, extending its swift 4.5% fall in less than three weeks.

Analysts at BofA said the yen could reach 123 per dollar by September. In the past, Japan would have welcomed a weaker yen, which would have boosted profits from exports. But with exports slowed by the pandemic and foreign manufacturing, those days are gone, analysts say.

“You have a higher oil price, and you have the widening interest rate gap, and the university fund is supposed to start investing by the end of this fiscal year, so I think overall there’s going to be more yen supply than demand in the coming months,” said Shusuke Yamada, chief Japan FX strategist at BofA in Tokyo.

The 10 trillion yen ($83 billion) university fund, which will begin investing by this month, is part of Prime Minister Fumio Kishida’s stimulus package and a chunk is meant to be parked in foreign assets.

Meanwhile, high energy prices caused in part by the war in Ukraine have caused Japan’s trade deficit to soar.

The world’s third-largest economy reported a wider-than-expected 668.3 billion yen trade deficit for February, smaller than January’s 2.19 trillion yen gap, which was the biggest in a single month in eight years.

has been above $100 per barrel for almost all of March, and rose as high as $139 early in the month. [O/R]

“The vicious cycle between a deteriorating trade balance and falling yen may have started already,” JPMorgan (NYSE:)’s Tohru Sasaki said in a note.

“Higher commodity prices will result in a larger trade deficit, which should result in a weaker yen,” he wrote, adding that because a lot of Japanese manufacturing was no longer based in the country, there would be no concurrent jump in exports.

JPMorgan recently raised its target for yen to 121 per dollar by the first quarter of 2023.

INTEREST RATE DIVERGENCE

Also weighing on the yen is the growing gap between Japanese and U.S. interest rates. Yields on 10-year Japanese government bonds are around 0.21%, and a sharp rise in U.S. yields – U.S. 10 year bond yields reached 2.35% on Tuesday – has taken the spread between the two markets to its widest since August 2019.

In theory, those low yields and expectations for yen weakness could spur more Japanese investors to sell their currency and turn their attention abroad, although in practice much of such flows are hedged and have only marginal impact.

GRAPHIC: Japan’s yen under pressure: https://fingfx.thomsonreuters.com/gfx/mkt/zgpomymmxpd/Pasted%20image%201647925341006.png

Japan’s yields are set to stay low. Bank of Japan…