Japanese Yen Slides Again as USD/JPY Resets Sights on 125
- Written by: James Skinner
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- USD/JPY rallies alongside US-JP yield differentials
- After U.S. unemployment hits pre pandemic level
- Market attention turning back to 125 in USD/JPY
- ”Intervention risk is limited at 125,” Nomura says
- But risk to rise if USD/JPY nears 130 line in sand
- USD/JPY seen turning lower in second half 2022
Image © Adobe Stock
The Japanese Yen tumbled during the final session of the week when the Dollar rose sharply alongside interest rate differentials and as stock markets advanced broadly amid an evident improvement in investor risk appetite, leading some to reset their sights on the 125 level of USD/JPY.
Japan’s Yen didn't benefit on Friday from further declines in crude oil prices, which were down by double-digit percentages for the week, but instead tumbled against all major currency counterparts and few more so than the U.S. Dollar.
The Dollar was lifted broadly after the March non-farm payrolls report showed the U.S. continuing to claw back jobs once lost to the coronavirus, with the unemployment rate falling to within arm’s reach of its pre-pandemic low.
While USD/JPY was already climbing beforehand, Friday’s data appeared to catalyse an extension of the move, taking USD/JPY back to 1.23 and fully reversing the fall seen on Wednesday after the finance ministry expressed concern about the Yen’s recent declines.
“With flows on the bottom and Japanese authorities sitting on the top, we think that the 120 to 125 range is likely to hold for most of Q2. However, we would give higher probability to a break of the range on the top,” says Greg Anderson, global head of FX strategy at BMO Capital Markets.
Above: USD/JPY shown at 15-minute intervals alongside GBP/JPY. Click image for closer inspection.
The U.S. economy added some 413k jobs in March while the unemployment rate dropped to 3.6%, leaving it just 10 basis points from the historic low of 3.5% seen in the final months of 2019.
Economists and analysts say this would likely encourage the Federal Reserve (Fed) to lift its interest rate at a faster pace than it has in any moderny monetary cycle as it seeks to contain inflation that has surged to multi-decade highs.
“Unless the BOJ abandons yield curve control (rather than just incrementally raising the target) and adopts a hawkish stance/begins to tighten policy, something it has not done with any serious gusto for nearly two decades, it will not offset the tidal wave of higher US yields and Fed funds rate,” says Mazen Issa, a senior FX strategist at TD Securities.
“The net result is that the interest rate differential channel will remain more favorable for the USD than the JPY,” Issa said on Thursday this week.
Above: USD/JPY shown at daily intervals alongside spreads - or gaps - between 05 and 10-year U.S. and Japanese government bond yields. Click image for closer inspection.
While the U.S.-Japan interest rate differential is likely equally as significant as any other factor that has been cited as contributing to the six percent uplift in USD/JPY last quarter, if not more so, there are also other factors likely to be contributing to decline in the Yen too.
“So we expect the oil price to gradually decline in the second half. Lower oil price will change Japanese Yen’s international dynamics quite significantly and lower oil prices can lower inflation and expectations outside of Japan so expectations for very aggressive rate hikes may ease somewhat. In this scenario Dollar-Yen strength will weaken as the oil price peaks,” says Yujiro Goto, head of FX strategy at Nomura, in the podcast below.
This year’s 35% increase has taken international oil prices over and above $100 per barrel and could lead to an additional $10BN per month in foreign exchange outflows from Japan, according to Nomura’s Goto-san and colleagues.
“Assuming oil stays north of $100/bbl, we think that core flows will remain JPY-negative. And then lastly, there is the widening interest rate differential, which pulls upward on USDJPY as US short-term interest rates rise,” says Greg Anderson, BMO Capital Markets’ global head of FX strategy.
Above: USD/JPY shown at weekly intervals alongside GBP/JPY and Brent crude oil price. Click image for closer inspection.
“The further out in time that we look, the more we think that time favors a break above 125. We don't think that 130 will break during calendar-year 2022, though,” BMO's Anderson and colleagues said on Friday.
Rising oil prices and rising U.S.-Japan interest rate differentials are a particularly inebriating cocktail of macroeconomic and financial headwinds for the Japanese Yen, hence how it has found its way back to the bottom of the major currency league table during the opening months of 2022.
However, this has already drawn expressions of concern from Japanese politicians who’ve control over the country’s foreign exchange policy and the Nomura team warned on Wednesday this week that the risk of direct market intervention would increase notably if USD/JPY was to approach 130.
“And if inflation keeps rising and the public opinion is negative against higher inflation or Yen weakness, the Finance Minister Suzuki or Prime Minister Kishida will sound more negative about higher inflation and Yen weakness and the impact can be even stronger in the second half as Kuroda-san’s retirement approaches,” Goto-san told London-based colleague Jordan Rochester.