More from Citi FX’s ‘Strategy Weekly’ client note for this week.

It asks: “A perfect storm for EURJPY?” and goes on to explain why downside pressure could increase as we approach September:

A combination of new ECB easing measure:

  • Weaker data out of the Eurozone
  • Worries about the outlook of the banking sector could increase the chances of more ECB measures as soon as September
  • These would come on the back of the already announced T-LTRO measures and could boost the size of ECB’s balance sheet
  • In particular, Citi economists expect the governing council to announce a target for ABS purchases
  • The measures could be followed by outright QE as soon as December.

Japanese exporters’ hedging could weigh on EUR and support JPY

  • Flows …. we have concerns on EUR selling from Japanese corporates could intensify going forward
  • Japanese exporters, who have set the forward hedging ratio at unusually low levels over the last year, are under-hedged at present
  • Most of them recently set their budget rate for EURJPY at 135, revising up for last half year. A few companies have even set the rate at 140
  • Following the pair’s drop below 140, the 138 level could become an attractive entry point for new hedging
  • Corporates tend to step up their hedging activities as we move closer to mid-fiscal year in September
  • EURJPY could be more vulnerable to corporate hedging activities than USDJPY. In the case of the latter, we can expect a number of buyers such as Japanese importers or investors. Given that Japan is currently running a trade deficit and that most of Japanese imports are denominated in USD, the dollar inflows could be larger than outflows
  • Japanese lifers and other investors are showing some interests in potentially lowering the FX hedging ratio
  • We believe USDJPY will be supported once the pair falls below 100. On the other hand however, we cannot expect such potential buyers for EURJPY

Also:

  • Recent assets underperformance could weigh on demand for EUR-denominated assets
  • The impact from a new BoJ QE before could be more than offset by more aggressive easing measures by the ECB in coming months
  • We expect some renewed JPY weakness going into year end, when the BoJ’s additional actions and the GPIF reforms are expected, and the policy makers in Japan try to push up the growth rate and the markets (especially Nikkei and USDJPY) before the final decision on the 2nd round tax increase by Prime Minister Abe this December
  • If anything, however, we expect both JPY and EUR to lose ground against the dollar especially as more unconventional ECB measures keep the headwinds for euro in place across the board