BNY’s Geoff Yu notes that clients have largely capitulated on Japanese Yen (JPY) and South Korean Won (KRW) longs as these currencies stay weak versus US Dollar (USD) and Chinese Yuan (CNY). He argues that fundamentals offer limited justification for further weakness and that U.S. strategic considerations around AI (Artificial intelligence) supply chains could trigger a policy push. Such a shift might catalyze a material strengthening in JPY, KRW and Taiwan Dollar (TWD).

Capitulation sets stage for upside risk

"China’s silence on JPY, KRW and TWD valuations is as surprising as the lack of U.S. pushback. Although Treasury Secretary Scott Bessent highlighted in January that the KRW wasn’t trading in line with fundamentals, the KRW has weakened further but hasn’t generated much pushback. The decline in oil prices means the fundamental justification from a balance-of-payments perspective is also much weaker."

"iFlow indicates that any residual positioning in JPY and KRW longs by cross-border clients has collapsed. Intervention clearly isn’t designed to strengthen currencies structurally, while potential rate hikes by central banks in the region will also be soft relative to developed market peers outside of Asia."

"Fed Chair Kevin Warsh’s comments yesterday weren’t seen as excessively hawkish, so the USD carry angle is weakening as well as a driver."

"If the U.S. can’t make an argument for USD to adjust versus JPY, KRW and TWD on a fundamentals basis, geopolitics and strategy could be the more relevant angle. Current weakness in these currencies versus the USD and CNY is dampening the cost of purchases. The U.S. may take a view on whether this aligns with strategic priorities in AI."

"A new push, either openly or behind the scenes, could change behavior, especially with JPY and KRW where markets are now positioned the other way. This means that a sudden adjustment could pay off in material strength for JPY, KRW and TWD. Signaling through the semiannual currency report is another option."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)