Chart 1: USDJPY vs yield spread Chart 2: USDJPY carry* gradually inching up Mp oon eee eee 130 135.0 0.50 We | IMAL AL See exec mrs as 129 125.0 hex 0.40 10 I, v: _ OTERO orc cocoon 120 115.0 : 0.30 il oem nn een 105.0 : 0.20 06 po -- Ro an") | | ns 95.0 : 0.10 D4 pam ne iM WT 105 85.0 0.00 al 0.2 pom n mem nn eee ee ee een nese ewe = = 100 75.0 0.10 A NY N\ < > * SY © r : FPF FMF MLK Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 —=—==USDJPY(RHS} —====USDJPY carry / 3m implied vol (RHS} em (JS-Japan 10yr real yield spread (LHS) === USD'JPY (RHS) Source: BofA Merrill Lynch Global Research, Bloomberg Source: BofA Merrill Lynch Global Research, Bloomberg *Using 3m deposit rate JPY sellers > JPY buyers While uncertainty is high, what is more certain is that there are more potential sellers of JPY than its buyers. This is the opposite of the situation some months ago (USD/JPY’s downside risk to 110 — sell on rally 10 February 2016). First, CFTC speculative position remains yen long though short-term traders are probably positioned for the upside already (Chart 3). Second, we believe domestic activity to raise hedge ratio has run its course as the USD/JPY swept through the sensitive level this year. As 2HFY16 (Oct ‘16- Mar ‘17} has started, most life insurance companies are reportedly inclined to increase exposure to unhedged foreign bonds though they generally remain price sensitive. In our view, this is reflected in the USD/JPY’s consolidation during Tokyo trading hours after the pair hit 100 on the Brexit vote (Chart 4). The fact that USD/JPY has failed to break 100 multiple times since then suggests the market looking for USD/JPY’s dip, light positioning, and the market’s judgment that USD should be more expensive than 100 JPY. The market is probably more vulnerable to the USD/JPY’s upside than downside. Chart 3: CFTC non-commercial futures position (bln USD) Chart 4: USD/JPY cumulative % change by trading zone 5 9 e=—= During Japan Trading Hour(8am-