Dollar-Yen: Collapse Below 140 On the Cards

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The Dollar to Yen exchange rate (USD/JPY) is forecasted to make a break below the important 140 barrier as further interest rate convergence between Japan and the U.S. looks assured.

The Yen's comeback from multi-decade lows extended midweek after Junko Nakagawa, a member of the Bank of Japan's decision-making board, said further rate cuts are likely.

"Given real interest rates are currently very low, we will adjust the degree of monetary support, from the standpoint of sustainably and stably achieving our 2% inflation target, if our economic and price forecasts are met," she said in a speech on September 11.

The communication is consistent with Bank of Governor Kazuo Ueda saying on August 23 that further rate rises should be expected if the economy and inflation perform as expected.

"Assuming real wage data continues to improve, and growth prospects remain on target, the BoJ could hike again before year end," says Jane Foley, Senior FX Strategist at Rabobank.

Expectations for further Bank of Japan hikes contrast with expectations for cuts in the U.S., Eurozone and UK before the end of the year, which will lower the Yen's long-running interest rate disadvantage on global currency markets.

"USD/JPY looks set for a bigger drop due to various factors affecting the US, focus on interest rate differential convergence between the Federal Reserve and Bank of Japan, and the bearish medium-term chart," says Martin Miller, a Reuters market analyst.

"USD/JPY will likely collapse below the 140 psychological level," adds Miller.

His studies of the medium-term USD/JPY chart show a bearish set up with spot trading well below 144.59, which is the 50% Fibonacci retracement level of the 127.22-161.96 (2023-2024) rally.

Sentiment will remain another important factor behind Dollar-Yen performance, with analysts saying the Yen can appreciate if the September swoon in global equity markets extends.

"Growing risks to the U.S. stock rally are spurring demand for portfolio hedging, options markets showed, as investors grapple with U.S. economic uncertainty, shifting Fed policy and a looming presidential election. In times of uncertainty, funds usually flow into the safe-haven yen," says Miller.

That said, September is a poor month for stocks and a strong one for the Dollar based on historical precedent. This seasonality could mask any real concerns for the U.S. and global equity market outllok.

Analysts at Capital Economics say demand for AI hardware doesn't seem to be waning, and this can drive the AI-inspired cyclical bull run.

In addition, they think the U.S. economy will experience a soft landing (i.e. a slowdown, and not a recession). "We are therefore sticking to our forecast for the S&P 500 to end this year at 6,000," says John Higgins, Chief Markets Economist at Capital Economics.

A strong end to the year for U.S. equities could bolster the Dollar and limit the Yen's advance.

"We have brought forward our previous 12 month forecast of USD/JPY 140 to a 6 month view," says Foley. If correct, any break below 140 near-term might not stick.