A post two years ago suggested that the yen would defy consensus predictions and strengthen further. The tide, however, may now be turning against the Japanese currency.

Consider trade. Higher fuel imports due to the nuclear shutdown contributed to Japan running a visible trade deficit of 1.0% of GDP in the year to the first quarter. This represents the worst performance since 1980-81 both in absolute terms and relative to the US. Movements in the US / Japan trade balance gap have often foreshadowed swings in the dollar-yen exchange rate historically – see first chart.

The impact of trade deterioration on the yen may have been offset until recently by rising real interest rate support – changes in the US / Japan real policy rate spread have also correlated with dollar-yen moves, as the second chart shows. Japan’s advantage, however, is now being eroded by rising prices – April’s CPI was 0.5% higher than a year before. The credibility of the Bank of Japan’s commitment to achieving 1% inflation has been enhanced by recent expansion of its asset purchase programme.

Shorter term, the dollar-yen rate displays sensitivity to the absolute level of US Treasury yields – third chart. Speculators now hold the largest net long position in Treasury futures since January and are often a good contrarian indicator, suggesting a summer rise in yields and accompanying yen weakness.

The main caveat to a yen-bearish view is that the consensus still expects weakness – currencies usually begin major declines when sentiment is at a bullish extreme. Positioning, however, may be modest given the failure of bearish predictions in recent years, a suggestion supported by the latest Merrill Lynch global fund manager survey, showing a lower net percentage judging the yen to be overvalued than in 2010-11.