Jane Foley, Research Analyst at Rabobank, suggests that the rebound in risk appetite since the middle of February has allowed the DJIA to recoup all of the losses registered at the start of the year. Key Quotes “The DAX has recovered around 73% of its fall but by contrast the Nikkei 225 has only covered 50%. The simplest explanation for the underperformance of Japanese stocks is the continued strength of the JPY. However, it is notable that the JPY has not weakened over the past month as stock markets and risky assets have recovered. Despite the improvement in general levels of risk appetite in recent weeks and the BoJ’s announcement of negative interest rates on January 29, the JPY has proved reluctant to relinquish its safe haven inflows. In addition to the JPY, Japanese bonds have also been in demand. The more dovish than expected tone of the Fed this week had the impact of depressing bond yields in general. Heightened investor demand for JGBs has been reinforcing concerns about a lack of supply which were already prevalent given the BoJ’s enormous QQE plan. Speculation that QQE could be extended later this year has further enhanced fears of JGB supply shortages. Although low yields will usually trigger a weaker currency, according to Bloomberg foreign investors have been able to used favourable cross-currency basis-swaps to bolster returns from JGB which has underpinned demand for the paper. Portfolio flows appear to validate the view that there has been overseas demand for JGBs. Data released by the Ministry of In total Japanese net international portfolio flows have seen an increase of JPY 2762 bln over the past 5 weeks which in turn has helped support the JPY. Looking ahead we do see scope for the JPY to relinquish some ground against the USD in the coming months. This view depends on two key factors. The first is the assumption that US inflation indicators will pick up to allow the Fed to hike interest rates this year potentially as soon as June. On an anticipated rise in US bond yields we would expect flows to be drawn into the greenback. The second factor assumes that he Fed can engineer this without sending investors scurrying into safe haven assets such as the yen. Even if this is achieved we do not expect USD/JPY to rise too far this year. In view of the slow pace of world growth, concerns over the effectiveness of extraordinary monetary policy settings and the plethora of political risks we have a 12 mth target at USD/JPY116.” For more information, read our latest forex news.