Bank of America Merrill Lynch (BAML) is tipping 5-year real rates to rise in the United States and says buying the dollar at the expense of the yen is the best trade to make a profit.
The post-election Trump effect on the dollar has unwound, falling more than 2 percent against the yen in the opening weeks of 2017.
During the same time stocks and commodities have continued to perform well. But BAML says this divergence won't last. Instead, the investment bank sees higher global rates returning and that in turn will be dollar supportive.
"The low level of five year real rates across G-4 countries is not consistent with tighter policy from both the U.S. and China, and the risks skewed toward tighter rather than easier monetary policy in the rest of the world," the note read Thursday.
BAML says the year-to-date experience has been one of lower real rates and higher break even rates. The break even rate is the difference between the yield on a nominal fixed-rate bond and the real yield on an inflation-linked bond.
The bank expects U.S. real rates should rise back to levels seen at the end of 2016 within months and whether break even rates go up or down, history tells us the yen should fall.
"If U.S. real rates rise, long USD/JPY offers the best risk-reward irrespective of the direction of break evens/reflation trades," the note said.
BAML noted that concern about President Donald Trump's protectionist policies could result in "trade friction" which in turn puts a stronger dollar theory at risk, but argues the spicy rhetoric is cooling and that China is willing to work with Trump's team.
Jane Foley, head of foreign exchange strategy at Rabobank, is not in full agreement that the yen is set to fall.
She told CNBC Wednesday that the yen could still benefit from its reputation as a safe haven and investors still have concerns around Trump inspired protectionism.
"We have seen the market coming back on the yen a bit which is of course a safe haven play and if Trump's protectionism goes forth, there will be more concern about China, and that is supportive for the yen on the safe haven flow," she said.