Yen Weakening Into Key Bank of Japan Decision

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Market Strategy: Selling USD/JPY on Rallies

The Japanese yen has weakened ahead of a crucial Bank of Japan (BoJ) policy meeting, with the USD/JPY exchange rate climbing back to the 150.00-level.

The currency’s recent slide reflects growing market anticipation regarding BoJ’s stance on interest rates, as well as external influences such as rising U.S. Treasury yields and stronger-than-expected U.S. retail sales data.

A significant driver of the yen’s depreciation has been the steady increase in U.S. bond yields. The U.S. 2-year Treasury yield, which hit a low of 3.83% on March 11, climbed to 4.06% following robust U.S. retail sales data for February.

The report showed a 1.0% month-over-month increase in control retail sales, reversing January’s 1.0% contraction. This data has eased concerns about a sharp slowdown in the U.S. economy, prompting investors to reassess their expectations for Federal Reserve rate cuts.

"USD/JPY has been supported by the pick-up in US yields over the past week," noted Lee Hardman, Senior Currency Analyst at MUFG Bank Ltd. "The strength of U.S. retail sales has reinforced expectations that the Fed will remain cautious about cutting rates in the near term."

The strengthening U.S. dollar, closely tied to short-term yield spreads, has placed additional downward pressure on the yen. The market remains sensitive to any policy cues from both the Federal Open Market Committee (FOMC) and the BoJ, with both institutions set to announce their latest policy decisions tomorrow.

Market expectations overwhelmingly indicate that the BoJ will maintain its current policy stance. However, speculation around the central bank’s terminal rate has intensified following recent speeches by BoJ officials. A Bloomberg survey of 52 economists pegged the median expected terminal rate at 1.25%, with estimates ranging from 0.50% to 2.50%.

"While the market is fully priced for no immediate change in BoJ policy, recent discussions around the terminal rate suggest the potential for a higher level than previously anticipated," Hardman commented. "Investors will be closely watching for any signals from Governor Ueda regarding this."

Deputy Governor Shinichi Uchida recently underscored the uncertainty surrounding the terminal rate, emphasizing that the BoJ does not have a predetermined target. Meanwhile, Policy Board Member Hajime Takata suggested that conditions are evolving toward a normalization of policy. As a result, expectations for rate hikes have gradually risen, with the market now pricing in a terminal rate near 1.20%, up from around 0.90% at the end of 2024.

Wage Growth and Inflation Considerations

Japan’s wage growth data remains a critical factor in the BoJ’s decision-making process. The recent Rengo wage negotiations delivered a stronger-than-expected outcome, with an overall wage increase of 5.46% and a base pay rise of 3.84%. These figures exceeded Bloomberg’s consensus estimates of 5.1% and 3.4%, respectively, reinforcing expectations that the BoJ could pursue further rate hikes.

"The Rengo wage announcement is a very important part of the BoJ’s inflation outlook," Hardman stated. "The latest figures provide Governor Ueda with room to signal further hikes ahead. We expect the next 25bp hike in July, but there is a risk of it coming sooner, in June."

Governor Kazuo Ueda is expected to reaffirm the central bank’s progress in reaching its inflation target, potentially laying the groundwork for a 25-basis-point rate hike in July, or even earlier in June. While the BoJ is unlikely to signal an immediate policy shift, market participants will scrutinize Ueda’s remarks for any hints of a tightening bias.

Market Strategy: Selling USD/JPY on Rallies

Given the evolving outlook, analysts at MUFG maintain a strategy of selling USD/JPY on rallies. "We would expect the recent adjustment in terminal rate pricing to be maintained following the BoJ meeting," Hardman remarked. "Our bias remains selling USD/JPY on rallies, as the prospect of higher Japanese rates continues to build."

As markets await tomorrow’s dual central bank decisions from the BoJ and the Fed, traders will remain focused on any policy signals that could shape currency movements in the weeks ahead.