JPY: Stronger yen driven by fundamental drivers rather than intervention

The yen has strengthened sharply over the couple of trading days resulting in USD/JPY falling back towards the 155.00-level. It has proven to be an important support level so far this year after it held following intervention driven yen gains in late April/early May and in late July/early August. On this occasion the sharp strengthening of the yen appears to have been driven by fundamental drivers rather than intervention which increases the likelihood of a more sustained rebound. The latest BoJ current account data released yesterday showed no sign of major intervention to support the yen. Instead, the stronger yen has been encouraged by building expectations for a faster pace of BoJ policy tightening under pressure from the US. Treasury Scott Bessent’s recent comments on CNBC that “I have information the market does not have” followed by reports that he expressed concerns to Finance Minister Katayama regarding fiscal policy and central bank independence at the G20 Finance Ministers and Central Bank Governors meeting have fuelled speculation over a potential policy shift in Japan. Furthermore, hawkish comments from BoJ officials including Governor Ueda at the start of this week have signalled that a rate hike is likely this month. 

A view backed up by a Bloomberg report yesterday stating that the BoJ is leaning toward raising its policy rate by 25bps this month in response to upward price risks, while leaving open the possibility of accelerating the pace of hikes thereafter, according to people familiar with the matter. BoJ officials reportedly continue to see inflation risks as skewed to the upside, with service prices and ongoing weakness in the yen strengthening the case for action. However, the report did dampen more extreme speculation over the possibility of even a larger 50bps “jumbo hike”.  The Japanese rate market has already moved along way now to price in faster pace of BoJ rate hikes. There are almost 50bps of cumulative hikes priced in by year-end and just over 75bps of hikes by the middle of next year. A slightly faster pace of hikes than our own forecasts for a further 75bps of hikes (click here).

At the same time, the yen has derived some support as well by renewed speculation over the potential for the GPIF to shift their asset allocation towards domestic assets which would help to ease capital outflows into overseas markets that have been weighing on the yen. Bloomberg highlighted yesterday that there had been an unusual meeting of the GPIF’s management committee on 21^st August. It’s first publicly announced meeting in a holiday month in seven years according to a statement from 31^st August. The agenda reportedly included a report from a team that works on operation matters such as carrying out asset allocations, despite the group having concluded in March that a review of its holdings wasn’t needed. The report has added to speculation over the potential for the GPIF to shift allocations toward domestic assets in the future. The current asset allocation targets already allow some leeway to increase domestic asset holdings. Yields on long-term JGB yields have also dropped back from its recent highs in recent days. Fiscal policy under the Takaichi administration remains a concern. It has been reported that Japanese ministries have requested JPY143.1 trillion in total spending for the upcoming fiscal year which topped last year’s requests for JPY122 trillion. It is more in line with last year’s initial budget combined with the supplementary budget which together totalled JPY140.6 trillion. It reflects a change in the budget strategy to move away from the need to compile supplementary budgets.    

USD/JPY IS TESTING IMPORTANT SUPPORT LEVELS

Source: MUFG Research, Macrobond, Bloomberg

USD: Fed rate hike expectations scaled back ahead of NFP report

The move lower for USD/JPY in recent days has also been driven by the weaker US dollar. Prior to last week’s hawkish Jackson Hole speech from Kevin Warsh, EUR/USD was trading close to 1.1640 and then fell to a low early this week of 1.1566. The pair has cine risen back close to pre-Jackson Hole levels in recent days encouraged by the scaling back of Fed rate hike expectations. The US rate market currently judges that there is close to a 50:50 probability of a Fed rate hike this month after it was pricing in closer to a 70% probability of a hike at the start of this month. The dovish repricing of Fed rate hike expectations in recent days has been encouraged by the cautious comments from the Fed’s leadership over the need for rate hikes.

New York Fed President Williams stated that recent inflation data has been “encouraging” and he see “the trend in inflation moving slowly down as some of the effects of the tariffs move into the rearview mirror”. He added that the Fed is collecting a lot of data now, and will reassess whether rates remain in a good place for the economy. Fed Governor Waller also signalled that he was not in a rush to raise rates this month when he spoke yesterday. He stated that while inflation is “meaningfully” above the Fed’s target, he’s seeing signs of cooling in recent data. “If this continues in the data due over the next two weeks, I would be inclined to support holding the target for the fed funds rate at its current setting”. The release of the August CPI report on 11^th September appears increasingly pivotal in determining whether the Fed will hike rates ahead of the mid-term elections in November. In contrast, the Fed is less concerned over health of the labour market. Kevin Warsh’s Jackson Hole speech downplayed the recent softening in private employment growth which has averaged 40k/month in July compared to the average so far this year of 72k/month. He placed more focus on the stability of the unemployment rate. As a result, we expect today’s nonfarm payrolls report to prove less important for Fed rate hike expectations than next week’s CPI report helping to dampen the impact on US rates and the US dollar.