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Can the yen rally in the absence of Japan central bank hawks?

10:44, 5 July 2022

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Yen bill on a stack of dollars
The yen has hit 24-year lows against the dollar in 2022 – Photo: Yuji Sakai

Then yen has been the most shorted currency of any forex cross so far this year, but are there any indications it could mount a rally in the second half – even without strong backing from its central bank? 

USD/JPY rose on early Tuesday, briefly rising above the 136 level before retreating to the 135.70-135.65 region during the first half of the European session. 

But the yen failed to capitalise on Japan’s services PMI increasing at the fastest pace since 2013, at a time when the country is counting on strong domestic demand to support its economy as the depreciation of the yen causes a headache for businesses and rising inflation squeezes consumers. 

The USD/JPY pair briefly reached 136.98 at the end of June, a level not seen since August 1998. 

So is the pair still on a one-way street, and what will traders be looking for that could see the yen begin a turnaround? 

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USD/JPY exchange rate

Data to come

The yen’s fall against the dollar this year has primarily been driven by Federal Reserve hawkishness, in contrast with the Bank of Japan’s continuing ultra-loose monetary policy, which has put it at odds with all other major central banks. 

In its most recent meeting in late June the Japan's central bank stuck to this course; meanwhile, eyes will be on Federal Open Market Committee (FOMC) meeting minutes being released on Wednesday for an indication of its current thinking.

From Japan this week, Wednesday will see the release of foreign investment data, followed by its Leading Economic Index, bank lending and trade balance on Thursday, giving an updated economic snapshot. So can the yen rally if these data-points indicate the economy remains on a growth trajectory?

Turnaround ahead?

“To a large extent, the market is currently pricing in ‘peak hawkishness’ from the Fed,” Jonathan Petersen, senior markets economist at Capital Economics FX Markets, told 

“Rather than aggressive tightening followed by a pause, investors’ expectations now seem to be that the Fed will need to rapidly cut rates sometime in mid-2023.

“This is one key reason why bond yields in the US have fallen and the yen has remained stable rather than continuing to depreciate beyond 136/$: rate hike expectations are being priced out of other G10 economies amid a worsening global outlook, while expectations for BoJ policy have remained mostly unchanged.”

Wider factors

To a lesser extent, the fall in commodity prices, notably oil, mean that Japan’s terms of trade have shifted in the yen’s favour over the past few weeks, Petersen said. 

“As a net energy importer, higher energy prices were a headwind for the yen through much of the post-pandemic period. If downside risks to the global economy materialize, then demand for (and the prices of) commodities are likely to fall, benefiting the yen.

“In addition, it is worth noting that the yen’s rapid pace of depreciation have left it well-below the longer-term average of its effective exchange rate (i.e., the trade-weighted exchange rate). So, the yen is arguably undervalued.

“In short, the prospects for the yen to rally are closely tied to the outlook for the global economy. In the case of a substantial slowdown (or recession), bond yields and commodity prices would probably fall, shifting from headwinds to tailwinds for the yen,” he said. 

Dollar index (DXY)

Can the yen rally?

“The dollar is most definitely overstretched,” said chief market strategist David Jones, “but someone could also have said that a couple of months ago and it carried on higher.”

“Many a trader’s fingers have been burnt trying to call the top in the dollar or the low in the yen this year.”

The dollar index (DXY) rose above 106 Tuesday, a level last seen in January 2002. 

“When the yen does rally, it seems unlikely that this will be an explosive move so I think there will be plenty of time to jump on a yen resurgence,” Jones said. 

“I think for now the watchword is to be patient and wait for the price to confirm any reversal. Given that the US dollar hit a multi-year high just in the last five days, I don’t think we yet have the signs of a yen comeback, even though many of us will be thinking that surely the known rate rises are now priced into the US dollar.”

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