USDJPY fundamental analysis: Is the yen out of the woods now?

2022年7月29日

The Japanese yen rose to 133 against the dollar (USD/JPY), recovering from its 24-year lows.

Short-term tailwinds are supporting the yen as the market has repriced Fed interest rate risks to the downside and has already priced in a rate cut in the first half of 2023. The yen is currently doing well in its traditional role as a recession hedge, with the US economy in a “technical recession” and the need to maintain growth “below potential” for a while in order to rebalance supply and demand. The yen has also recently received fresh support after Bank of Japan Deputy Governor Masayoshi Amamiya acknowledged that the BoJ should start considering the tools for ending ultra-loose monetary policy, even though the actual shift will not take place soon.

USD/JPY vs US/Japan 2-year spread

Treasury yields are falling, providing some relief to the rate differential between the United States and Japan, which has been the primary driver of the yen’s depreciation this year.

The 2-year yield spread between the United States and Japan has narrowed to around 300 basis points (or 3pp), as the US 2-year yield fell to 2.87 percent, while the Japan 2-year yield remained negative at -0.1 percent.

Despite this short-term narrowing of the US/Japan rate spread, the monetary-policy gap between the Fed and the BoJ still remains well in place, which may prevent the yen from strengthening too much against the dollar, unless some major catalysts occur.

What could push USD/JPY below 130?

The first refers to disappointing US employment and economic data, which would support an economic slowdown. If this is coupled with easing inflationary pressures, it would strengthen market expectations of a Fed’s policy U-turn in early 2023, pushing the 2-year US/Japan differential to 2.5 percent or slightly below. This level is consistent with a USD/JPY pair in the 128-130 range.

The second factor that could support the yen’s resurgence is Japan’s rising inflation rate, which, despite remaining relatively low, has risen for 10 consecutive months, exerting pressure on the Bank of Japan to change its monetary policy.

Bottom line: short-term relief, but medium-term doubts

In general, the macro picture may be tilting in favour of the yen, at least in the short term, but the downside risks, in the medium term, are not over.

The Fed has already stated that the Q2 GDP figures should be taken with “a grain of salt” because the labour market remains very solid and tight for an economy in recession.

There will still be two inflation prints in the United States between now and the September 21 FOMC meeting. Despite the fact that the United States was already in a de facto recession in the first half of the year, inflation has continued to rise.
As a result, it will be remarkably difficult to bring inflation down quickly, implying that the Fed must maintain a hawkish stance for the months to come.

Analysis by Capital.com's forex and metals analyst Piero Cingari