How far can the yen's reversal go? Goldman Sachs bets the appreciation is "just beginning," while Morgan Stanley waries of policy failures and resuming its bullish stance on the dollar.

The yen surged by about 3% in just a few trading days, driven by rising expectations of a Bank of Japan interest rate hike and the possibility that the Government Pension Investment Fund (GPIF) might increase its allocation to domestic assets.

According to TrendFocus, Goldman Sachs believes that this rally is not simply driven by short-term carry trades, but rather by changes in Japan's domestic policy environment: rising expectations of a Bank of Japan interest rate hike, coupled with potential asset reallocation by GPIF (Japan's foreign exchange reserve index), could lead to sustained yen buying. This means that some factors that have long suppressed the yen are gradually turning into supporting forces.

Therefore, Goldman Sachs believes that the correction of the yen's long-term structural undervaluation may have only just begun . In contrast, while JPMorgan Chase is also optimistic about the yen's short-term performance, it believes that the market has already largely priced in the Bank of Japan's interest rate hikes and GPIF reallocation, and that the yen could quickly retreat if policy implementation falls short of expectations.

The key question now is whether the yen's current appreciation, driven by a shift in Japanese policy, can evolve into a sustained trend.

Goldman Sachs: The yen's strength has "just begun," and a policy shift is key.

Goldman Sachs believes that the current appreciation of the yen is mainly driven by two factors: rising expectations of interest rate hikes by the Bank of Japan, and market bets that GPIF may further shift its asset allocation towards the domestic market.

Among these factors, the potential capital flows brought about by GPIF are particularly noteworthy. The report cites the experience of 2020, pointing out that while GPIF officially announced adjustments to its foreign debt allocation targets at the end of March that year, related capital flows had already emerged in January and February, suggesting that actual capital adjustments may have occurred earlier than the official policy announcement.

Therefore, the report pays particular attention to the August International Securities Transactions (ITS) data released on September 7, believing that it may contain early signals of GPIF fund rotation.

Goldman Sachs believes that the weakness of the yen in recent years was largely due to the resilience of the US economy and the widening interest rate differential between Japan and the US. Now, with the Bank of Japan's policy shift and the potential adjustment of domestic asset allocation by GPIF, the structural headwinds previously faced by the yen are weakening and may even turn into support.

JPMorgan: Bullish in the short term, but the yen's appreciation faces the test of policy implementation.

However, JPMorgan Chase's assessment of the GPIF asset reallocation variable is clearly more cautious.

The agenda released on August 31 shows that GPIF held a management committee meeting on August 21, the first time in seven years that a meeting was held in August; the basic portfolio verification work, which had previously concluded in March that "no review was required," was also put back into discussion.

JPMorgan believes this means GPIF may be reassessing its asset allocation, but in the near term it is more likely to adjust within the existing allocation range rather than informally modifying the basic portfolio.

If domestic bond allocation rises from 26.91% to the upper limit of 31%, theoretically it would correspond to approximately 12.3 trillion yen in yen buying; if Japanese stocks rise from 23.81% to 31%, it would correspond to approximately 21.6 trillion yen, totaling approximately 33.8 trillion yen.

Meanwhile, JPMorgan believes that expectations for a Bank of Japan rate hike are already overheated. A September rate hike is nearly fully priced in, with the 1-year swap rate rising to approximately 2.13%, implying a tightening pace even higher than the bank's own forecast. If these expectations begin to cool, the yen may come under pressure.

JPMorgan Chase re-emerges as a dollar bull: Interest rate advantage remains undervalued, September CPI becomes a key variable.

JPMorgan Chase has a positive outlook on the US dollar in the medium term. The bank believes the dollar is still undervalued by approximately 3% to 4% relative to the interest rate basis, and that the resilience of the US economy is not fully reflected in the current dollar exchange rate.

The U.S. unemployment rate remained at 4.1%, lower than the Federal Reserve's year-end forecast of 4.3%. The report predicts that, assuming the Fed raises interest rates only once this year, the dollar's yield will still be higher than more than 50% of global currencies, approaching a 25-year high; if there are three rate hikes, this proportion will rise to about 58%.

Next, the US August CPI will be a key variable. Following the CPI release on September 11th, the FOMC will speak on September 16th, the Bank of England on September 17th, and the Bank of Japan on September 18th, with policy expectations from major central banks likely to be intensively repriced in a short period. Significant policy disagreements remain within the Federal Reserve, and inflation data will further test market bets on future policy paths.

For the US dollar, its future trajectory will depend on changes in US economic data and the Federal Reserve's policy expectations. If US inflation and employment data continue to show resilience, the dollar's interest rate advantage is likely to be further supported; conversely, if cooling inflation prompts the market to re-bet on easing policies, the dollar may come under pressure.

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