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How Low Can the Yen Go?

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The yen has been slipping and sliding for weeks now, thanks largely to calls for new stimulus from Japan's new prime minister.

With so many investors still short the yen, though, the trading situation is looking a bit more perilous. Really, how low can the yen go?

Potentially a lot lower, says Osamu Takashima, a currency strategist at Citigroup.

Takashima has calculated his forecast in terms of the dollar against the yen, so that a higher number translates to a weaker yen. He told investors in a recent note that "we won't say USDJPY95 is highly likely in the next few months, but at the same time we cannot rule out a possibility of it in the longer-term view point, for instance by the end of 2013." He also thinks the dollar could reach 90 yen by spring. That would be quite a change from current levels, with the dollar worth around 88 yen.

Not much would have to change to make Takashima's scenario become reality. Markets have known for weeks that Prime Minister Shinzo Abe would be pressing for more stimulus measures and a higher inflation target. Similarly, indications that the Federal Reserve might scale back its stimulus program ahead of schedule are already baked into forecasts.

What's happening, Takashima says, is that "the yen had strengthened to a level not supported by the interest-rate differential."

Takashima has looked at where the dollar might logically trade against the yen given the current difference between U.S. and Japanese interest rates. According to his calculations, if the difference remains around 0.16 percentage points the dollar ought to rise to 95 against the yen.

And if the Bank of Japan injects new stimulus, or the Fed takes its foot off the gas pedal? Fasten your seatbelts.

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