- USD/JPY rally may now be running out of steam.

- Nomura flags risk of reversal at or around 114.00 level.

- Yen has strong supportive fundamentals say Barclays.

© Andrey Popov, Adobe Stock

The USD/JPY has risen strongly in recent weeks although the rally is unlikely to extend much further, says Jordan Rochester, an FX strategist at Normura.

Rochester says the 114 level will represent a turning point for the exchange rate, with the Yen likely to push back against the Dollar at this point.

It has been argued by some that the recent rally was due more to US Dollar strength than Yen weakness, as investors sought the safety of the US Dollar as the China-US trade war escalated.

Above: USD/JPY shown at daily intervals.

US Treasury Bonds are widely considered the safe-haven of choice for investors and flows into them were thought to have been partly responsible for the rise; along with other factors, like relatively stronger US growth data and higher expectations of the Federal Reserve putting up interest rates compared to other central banks.

Nomura's Rochester disagrees, however, arguing that the recent rally in the pair is more to do with Yen weakness than Dollar strength.

"It is more Yen weakness in this scenario. We have actually seen quite large Japanese Yen outflows with data showing higher foreign purchases...So we have seen EUR/JPY leading the march higher rather than USD/JPY, it has been a very nice trendline in EUR/JPY, so for us it is very much a Yen story," says Rochester in an interview with Bloomberg News.

The Yen is considered one of the most sensitive safe-haven currencies in the world so if trade or global growth concerns ratchet up it is expected to recover ground vs the US Dollar.

"I think actually trade might start moving towards the Japanese angle in a couple of weeks time," says Rochester. "I think we will get 113.50-114 in USD/JPY then it will probably top out because at that point we probably have trade war/fears again."

Other analysts are also bearish the pair, including Marvin Barth, chief FX strategist at Barclays, who offers three fundamental reasons why he sees the Yen appreciating.

"The yen continues to be one of the most undervalued currencies out there is long-term Purchasing Power Parity (PPP) terms," says the strategist." "Second, increasingly it demands a greater share of global asset allocation for its correlation benefits not its yield benefits because it is such a great hedge on risk, particularly in the current environment...On a per capita basis it has actually been one of the strongest economies in the world over the last several years."

The reason why the Dollar has been outperforming the Yen recently is because when looked at on a "high frequency basis", the correlation between US and Japanese yields and USD/JPY is high. But on a "low frequency basis", the USD/JPY is going in the opposite direction to the yield differential, due to long-term valuations supporting the Yen.

There has also been some "momentum chasing" says Barth. "We had a big merger and acquisitions move come through very iliquid markets last week and USD/JPY popped higher. Everyone thought this is the big move for the USD/JPY. I'd fade it."

That the Yen will outperform the US Dollar if risk aversion increases is also the view of Esther Reichelt, an FX strategist at Commerzbank, who argues; "I mean fundamentally it might seem justified for a weaker Yen because the Bank of Japan has a substantially more expansionary policy than the Fed, however, the Yen is the best safe-haven in times of trouble and I think there is more trouble to come from the trade war side." says Reichelt.

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