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Chart 1: USDJPY vs yield spread Chart 2: USDJPY carry* gradually inching up ‘4 135.0 we 125.0 10 115.0 Os 105.0 us 95.0 04 85.0 0.2 15.0 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 s==USDJPY(RHS) <= USDJPY carry / 3m implied vol (RHS) US-Japan 10yr real yield spread (LHS) == USDAJPY (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 % e=—= During Japan Trading Hour(8am-4pm Tokyo) GOP 6 > ===—=—=NY Hour (Oam-8am Tokyo) sweep ‘| === London hour (4pm-12pm Tokyo) 7 EUR GBP CHF CAD NZD AUD JPY 8 4 ite -20 4 Brexit , , 22 J m= Nov "15 m Nov 16 Nov-15 Jan-16 = Mar-16. = May-16 = Juk16. = Sep-16.—sNov-16 Source: BofA Merrill Lynch Global Research, Bloomberg Source: BofA Merrill Lynch Global Research, Bloomberg Technical: constructive Daily overbought momentum (RSI) is overall a positive for USD/JPY’s uptrend. Overbought conditions can persist longer in uptrends, but at some point this could Bankof America 2 Japan Macro Watch | 14 November 2016 Merrill Lynch HOUSE_OVERSIGHT_014425