G10 FX Weekly: USD/JPY Upside Remains Compelling, But Beware Intervention
- By Richard Jones
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Although fundamentals suggest that USD/JPY can continue rallying, the threat of official Japanese intervention in the FX market to oppose JPY weakness means we are neutral USD/JPY at this elevated level.
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Summary
- The Bank of Japan (BoJ) enacted small alterations to its monetary policy this week.
- This led to a big drop in the Japanese yen (JPY) and a rise in the 10-year Japanese government bond (JGB) yield.
Market Implications
- USD/JPY traded very near the 30+ year high seen in October last year (151.95), with the 10-year JGB yield edging within a few basis points (bps) of 1%, trading at a ~10-year high.
- Although fundamentals suggest that USD/JPY can continue rallying, the threat of official Japanese intervention in the FX market to oppose JPY weakness means we are neutral USD/JPY at this elevated level.
Introduction
Even though the BoJ adjusted its monetary policy slightly more hawkish this week, USD/JPY has traded considerably higher in the past few days – very near last year’s high just below 152, the highest level in 30+ years.
Even with the recent pullback in the pair, USD/JPY is on a strong run of weekly gains, rising 11 of the past 14 weeks.
Given the sharpness and pace of the ascent, we are reticent to advocate long USD/JPY positioning, despite the compelling fundamental drivers underpinning the pair’s rise this year.
This is because of the threat of official intervention by Japan’s Ministry of Finance (MoF) to combat yen weakness. Like last year when the MoF intervened, there are compelling warning signs that Japanese authorities will support the yen in the FX market. Therefore, we are neutral USD/JPY.
BoJ Maintains Easy Monetary Policy
The BoJ tweaked monetary policy on Tuesday, removing the explicit language of capping Japan’s 10-year yield at 1% from its policy statement. The previous upper-bound cap of 1% on the 10-year is now a reference rather than a hard ceiling.
The central bank also raised its inflation forecasts for the 2023-2025 fiscal years.
It said it would continue with its Yield Curve Control (YCC) policy, controlling yields ‘mainly through large-scale JGB purchases and nimble market operations.’
JGB Yields Rise, JPY Falls
The 10-year JGB yield rose 6bp to ~0.95%, only a stone’s throw away from the 1% reference rate.
Even though the yield has retreated today after the sharp drop in US yields yesterday, it is poised to close the week at the highest weekly level in over 10 years.
Before the Bank of Japan announcement, a Nikkei story speculated that the central bank would tweak YCC and likely allow further flexibility in yield movements.
USD/JPY traded as low as 148.80 in response and was at 149.40 before the BoJ announcement.
USD/JPY Rallies on the BoJ, Upside Arguments Are Compelling
With the BoJ tweaking YCC rather than abandoning it entirely, USD/JPY reversed all its losses over the previous two trading sessions to trade to a new YTD high just below 152.
There may have been an element of ‘sell the rumour, buy the fact’ in USD/JPY price action after the Nikkei piece on Monday, perhaps adding to disappointment the BoJ was not more decisive with the YCC.
In a piece last week, Bilal suggested a YCC change would struggle to drive yen strength, citing the USD/JPY rally that followed the previous YCC tweak.
Moreover, he noted that the FX market cares more about Japanese short-end rates, which the BoJ left unchanged. Therefore, Bilal stayed bullish USD/JPY.
Without the threat of intervention, we broadly agree with Bilal’s view that USD/JPY is more likely to trade to 155 than 145.
Nonetheless, Official Intervention Is a Material Risk
However, we think the threat of official Japanese intervention calls for caution.
Although the 150 level itself is not necessarily important, market participants will recall that this time last year USD/JPY breached 150 and the Japanese Ministry of Finance (MoF) intervened to sell USD/JPY.
With USD/JPY trading around 150 throughout October, speculation remains that official intervention could occur soon. Having traded near 152 on Tuesday, that risk has increased.
When modelling USD/JPY on core FX drivers (nominal and real yield spreads, equities, oil, and USD), we generate an error between the rolling model estimate and the actual USD/JPY value. We expect this is market pricing of BoJ intervention (Chart 1).
The MoF Is Already Sabre-Rattling
After Tuesday’s BoJ policy announcement, in response to the sharp USD/JPY rally, the MoF warned the market about possible intervention.
Japan’s top currency official at the MoF, Masato Kanda, said authorities are ready to intervene: ‘We’re on standby … I can’t say what we’ll do, and when – we’ll make judgments overall, and we’re making judgments in a state of urgency.’
He added that ‘we’re very concerned about one-sided, sudden moves in currencies … Fundamentals don’t move several yen in one night.’
This is a clear warning that the MoF is concerned about the pace of yen weakness and that the authorities are poised to act.
The use of the wording ‘in a state of urgency’ caught our attention, leading us to believe that any further upside beyond this week’s high in USD/JPY could very easily see the MoF intervene.
What Happened Last Year When the MoF Intervened?
USD/JPY printed above 150 on 20 October 2022, with the pair sliding sharply on 21 October, following MoF intervention. USD/JPY closed at 147.65 on the 21st, sliding further in the coming weeks.
Over the month following that initial plummet on 21 October, the JPY appreciated against all its G10 peers (ex-NZD).
Within that month, the moves were even more extreme, with yen strength peaking against all G10 peers before moderating later in the period (Chart 2).
USD/JPY was clearly the big mover, with the pair falling over 14 big figures (peak to trough) following intervention and almost 10 big figures over the full 21 October to 21 November 2022 period (Chart 3).
USD/JPY Bulls Might Need to Be Nimble
Given the threat of intervention, traders will understandably be nervous about being long USD/JPY.
While there is no guarantee of imminent intervention, nor that price action will follow that of last year, the possibility of the MoF buying JPY in the market means we take a cautious approach.
Long term, the arguments for USD/JPY trading higher are compelling. But near term, the risk of intervention keeps us on the sidelines.