Yen’s Undervalue Against Dollar Continues, Says UBS

The Japanese Yen Remains Woefully Undervalued Against the US Dollar, Says UBS

The Swiss banking giant, UBS, has recently released an in-depth analysis on the valuation of several major currency pairs against the US dollar. A key finding from this report is that the Japanese yen continues to trade significantly below its fair value against the USD, making it one of the "cheapest" currencies in the G10 group.

UBS estimates the USD/JPY fair value at 125, which means that the current spot price of around 118-119 is roughly 6-8% undervalued. While this undervaluation presents a compelling case for a rerating of the yen against the dollar, UBS notes that arguments for convergence to fair value have weakened recently.

One key factor contributing to the persistence of this undervaluation, according to UBS, is the Bank of Japan’s (BoJ) reluctance to raise interest rates. Despite growing pressure from investors and market participants to take a more hawkish stance on monetary policy, the BoJ has thus far resisted making any significant adjustments.

Additionally, the Swiss bank cites a lack of significant pressure from the United States on Japanese authorities to strengthen the yen as another key factor preventing convergence to fair value. While some observers have argued that the US Treasury Department’s efforts to devalue its own currency through quantitative easing may ultimately lead to a strengthening of the dollar against other major currencies, including the yen, this issue is not seen as a significant driver of potential rate hikes by the BoJ at present.

The implications of UBS’ analysis for investors and traders are substantial, particularly in light of recent events. With global interest rates expected to rise further in 2023-24, driven by continued monetary tightening in major economies and growth concerns in China, many analysts expect a strengthening of the US dollar against other majors – including the Japanese yen.

In the case of the euro, UBS has marginally lowered its EUR/USD fair value estimate to 1.1340, placing it slightly below the current spot price. This revised estimate reflects recent changes in market sentiment and trends related to the single currency. Specifically, the bank notes that European fiscal stimulus packages introduced over the past year are seen as having had only a limited impact on boosting growth in the region.

Furthermore, UBS highlights that increased demand from European investors for foreign exchange hedging of their US dollar asset holdings is no longer an argument in favor of higher EUR/USD rates. Rather, this market dynamic is viewed by the bank as another factor driving lower valuations against the dollar.

However, it’s worth noting that despite these revisions to its valuation estimates, UBS still expects EUR/USD to reach 1.14 by the end of 2026 – roughly in line with its long-term fair value estimate. This view reflects a broader market consensus on this currency pair, which holds that previous arguments for a valuation overshoot driven by European fiscal stimulus or investor demand have largely faded recently.

**What’s Behind UBS’ Expectations?

To better understand the driving factors and assumptions behind UBS’ expectations on these major currencies, let’s take a closer look at some key points raised in their analysis:

• Interest Rate Changes: UBS’ analysts believe that changes in interest rates will continue to drive currency fluctuations.
  • The current market environment features several factors pushing up short-term interest rates in the United States:
    • Strong economic growth
    • Improved inflation outlook
    • Rising Fed funds target rate
  • Despite these positive trends, Japan continues to resist raising interest rates due to a weak economy and concerns over higher borrowing costs.
• Currency War Scenarios: While some observers expect the US Treasury Department’s pressure on the BoJ could lead to increased rate hikes in Japan, UBS cautions against this prospect. This disagreement between various opinions and UBS’ outlook could contribute to ongoing discussion around currency valuations.

In conclusion, key themes driving UBS’ analysis are:

1. Interest Rate Disparities: A fundamental aspect of the USD/JPY valuation.
2. Global Economic Conditions: With factors such as economic growth, inflation data, and monetary policy affecting asset values.
3. Central Bank Policies: Direct effects on currency markets via policy initiatives like quantitative easing or interest rate adjustments.

Given these variables, investors should remain vigilant when making decisions about their portfolios to account for ongoing developments in global and domestic economic conditions.