FX | Economy
FX Focus - USDJPY – Defending the Yen
Posted on| Forecast | Spot | 0 - 3m | 6 - 12m | Long-term |
|---|---|---|---|---|
| USDJPY | 144.7 | 160.00 | 150.00 | 130.00 |
*Forecasts as of July 2024.
- At its July 31st meeting, the Bank of Japan (BoJ) lifted the policy target rate from 0%-0.10% to 0.25% in a 7-2 vote and reduced the size of its monthly gross Japanese government bond (JGB) purchases (its QE program) from the current ~¥6.0trn to ¥5.31trn for August and September. The size will be further reduced by ¥400bn each quarter thereafter until January-March 2026 to reach ¥2.9trn (a 50% cut to its monthly bond purchases).
- Tighter BoJ monetary policy should yield a stronger currency, leaving the large global positioning in risk assets funded in Yen (Yen carry trade) highly exposed. Markets had begun to anticipate the BoJ’s move to tighten policy when tensions between the Japanese government and BoJ started to rise, resulting in Japan minister Kono publicly calling out the BoJ to hike rates to lift JPY which is "too cheap" while LDP official Motegi indicated the BoJ should clarify its rate normalization path.
- The tightening in financial conditions by the BoJ came amidst a cut to its Japan core inflation and GDP forecasts for FY2024 from the April outlook. BoJ’s decision to lift rates and cut bond purchases therefore looked more designed to address the government’s ire about a weak yen than based purely on Japan’s fundamentals. BoJ Governor Ueda seemed to confirm as much in his presser when he put the weak yen as a reason for his decision to lift rates. Still, BoJ’s forward guidance leaned slightly hawkish when it stated – “given real interest rates are at significantly low levels, if the outlook for economic activity and prices presented in the July Outlook Report is realized, the Bank will accordingly raise the policy rate and adjust the degree of monetary accommodation”.
- However, following the recent volatility in global asset markets caused by US recession fears and exacerbated by investors unwinding Yen carry trades, rates markets have been quick to reprice the Fed to deliver 125bp of cuts this year (vs 75bp previously) and 250bp in cuts to the end of 2025 (from 200bp previously). Fed pricing has moved to the dovish end of the spectrum leading to a weaker dollar. Markets have also repriced the BoJ, taking the 10-15bp hike priced earlier for October, off the table for now, but USDJPY has still managed to hit a multi-month low of 141.70 before rebounding.
- A 200bp compression between Fed Funds and the BoJ overnight rate to ~350bp or lower from the current 500bp may potentially yield a more sustained drop in USDJPY towards the mid 130s. Should the Fed and BoJ validate current rates pricing, the rates spread would shrink by only ~125bp to year-end, roughly half of what is likely required to get USDJPY back to the mid 130s. This looks to be a 2025 story. Yet, with Japanese policymakers (BoJ and the MoF) now more aligned to cap yen weakness, it is difficult to see USDJPY sustaining levels above 150.00 even if the Fed rate cut path proves to be less aggressive than what is currently discounted.
USDJPY selloff extends post the Bank of Japan’s July 31st meeting
Source: Bloomberg, August 6, 2024
