FX | Economy
FX Focus - USDJPY – Yen volatility rises as Bank of Japan’s meeting looms
Posted on| Forecast | Spot | 0 - 3m | 6 - 12m | Long-term |
|---|---|---|---|---|
| USDJPY | 153.95 | 160.00 | 150.00 | 130.00 |
*Forecasts as of July 2024.
- Volatility in USDJPY has spiked as the pair falls more than 8 big figures from 161.95 to 153.85 in just 3 weeks. The move comes ahead of the Bank of Japan’s (BoJ) July 31st meeting where expectations are building for a significant tightening in financial conditions. The question is what tools will the BoJ use and by how much will BoJ tighten financial conditions. This will determine how much further the Yen is likely to strengthen.
- The BoJ’s ultra-easy accommodative monetary stance consists of 2 policy tools – (1) an overnight cash rate currently at 0 – 0.1%; and (2) a quantitative easing (QE) program which sees BoJ purchasing JPY6trn in (mainly) domestic bonds and shares (to a lesser extent) per month to inject liquidity into the banking system. Much of the focus for the July 31st meeting centers on the latter where expectations are for the BoJ to announce a significant cut to its QE program (possibly by as much as 50%). This is subject to discussion with bond market investors but even with such a magnitude of cut to its asset purchases, that would still leave the BoJ creating more Yen supply, albeit at a slower pace. The Yen may stabilize at current levels should the BoJ cut its asset purchases, but it will hardly be in a position to reverse its decline that began in 2021.
- A compression in short-dated USD – JPY rates is likely the only way to sustainably strengthen Yen versus USD. A Fed rate cut cycle vs BoJ lifting rates to compress short-dated spreads by ~200bp or more from the current ~550bp may start the process of a more substantial decline in USDJPY. Such a move in short rates would likely lead to unwinding of long USDJPY positions by – (1) Leveraged players (hedge funds) who are positioned record short in Yen as a funding currency; (2) Offshore investors who bought Japanese stocks with FX hedged Yen funding will start to lift their forward hedges as they get more costly; and (3) repatriation into domestic assets by Japanese pension funds and life insurers as domestic yields become more attractive.
- Some members of the BoJ board now believe Japan’s macro backdrop is better placed to handle higher rates and point to the strong wage hikes achieved in this year’s Japan spring wage negotiations likely contributing to a more sustained lift in Japan’s demand-led inflation. Indeed, expectations are rising that the BoJ will upgrade its Japan inflation forecasts at the July 31st meeting. But perhaps the bigger reason to hope for the BoJ to begin rate normalization comes from the impatience of Japan’s Ministry of Finance (MoF) officials responsible for intervening in FX markets to cap Yen weakness, calling for the BoJ to have a clearer normalization roadmap on rate hikes and better market communication in order to stem excessive Yen depreciation. Having spent USD85bn in intervention funds in 3 the months since April/ May to cap Yen weakness only to see Yen weaken from ~153.00 to as high as 161.95, their rising impatience with the BoJ may be understandable.
USDJPY has fallen more than 8 big figures from 161.95 to 153.85 in just 3 weeks in July
Source: Bloomberg, July 25, 2024
