- USD/JPY has continued to weaken as the greenback struggles to attract bids on increased bets that the Fed could pivot from its ultra-aggressive hawkish policy.
- On the other hand, the yen is trading higher ahead of another BoJ meeting, which could further tweak its yield control policy.
The U.S. dollar fell against a basket of currencies in Monday’s light trading as traders bet on another yield control policy change by the Bank of Japan (BoJ) later this week.
The greenback’s weakness took the U.S. dollar index down to a 7-month low, extending its sell-off from last week after new data showed that U.S. consumer prices declined for the first time in more than two and a half years.
Analysts at MUFG said in a note,
"Every G10 currency gained versus the US dollar last week helped by the US inflation data for December, which confirmed a continued easing in inflation pressures that reinforces the prospect of the Fed pausing its tightening cycle, possibly after the March FOMC meeting,"
Cooling inflation signals that the Federal Reserve could finally slow the pace of its interest rate hikes, which were the main driver of the dollar index’s massive jump in 2022. According to current market estimates, there is a 91% chance that the Fed will hike interest rates by just 25 basis points at its policy meeting next month, while only 9% are expecting a 50 bps increase.
After U.S. Data, All Eyes on BoJ
The one to watch this week in the currency markets is the Japanese yen, as many speculate that the BoJ could further tweak or completely scrap its yield control policy at its meeting on Jan. 17 and Jan. 18.
Japan’s government bond market is one of the largest in the world, with more than 1,000 trillion yen ($7.9 trillion) of debt. However, it has become one of the least liquid bond markets due to BoJ’s monetary policy called yield-curve control.
In an effort to spur lending, growth, and inflation, Japan’s central bank has pinned short-term interest rates at -0.1% and 10-Year yields around zero since 2016. During that period, it reduced its tolerance for the movement of the 10-year yield above or below 0 three times - most recently last month when it expanded its target band from +/- 0.25 percentage points to +/- 0.5 percentage points.
Given that bond yields increase in value when prices drop, protecting the upper limit of the target band forced the BoJ to buy a substantial amount of bonds, which resulted in it owning more than 50% of the market.
The U.S. dollar hit a 7-month low against the Japanese yen in early Monday trading before slightly recovering later. Ray Attrill, head of FX strategy at National Australia Bank, said,
"I think the whole world will be focused on Wednesday, and probably the week in G10 (currencies) will be defined by what happens to the yen and yen crosses, out of that,"
Attrill believes the BoJ does not have “the luxury of time” to evaluate things further and wait until current Governor Haruhiko Kuroda completes his term to make any policy changes. Kuroda is set to step down from his position in April.
Investors have been calling for the BoJ to abandon its ultra-easy monetary policy, which caused the 10-year Japanese government bond yields to skyrocket and breach the central bank's new ceiling last week.
Japan’s ultra-easy monetary policy has been supporting global yields and has weakened the value of the Japanese yen. If the BoJ were to abandon this policy, it would likely put upward pressure on yields in developed markets and strengthen the yen.
Yen Enjoying Tailwinds, Dollar Facing Headwinds
The value of the U.S. dollar has been impacted by the falling U.S. bond yields as investors hope that the Federal Reserve will not keep raising rates as aggressively due to a decrease in inflation.
This drop in inflation also increases the chances of a soft landing for the U.S. economy, according to Alan Ruskin, global head of G10 FX Strategy at Deutsche Securities. He said the easing supply chain constraints in the recent period was turning out to be a disinflationary shock.
Ruskin said, according to Reuters,
"The lower inflation itself encourages a soft landing through real wage gains by allowing the Fed to more readily pause and encouraging a better-behaved bond market, with favorable spillovers to financial conditions."
A soft landing also mitigates the tail risk of higher US rates, which ultimately “helps global risk appetite," he added.
Morgan Stanley) forex strategists made a revision to their year-end target for the U.S. dollar as they now expect the index to close the year at 98 instead of the prior 104. Currency strategists led by James K Lord, said,
"Global growth is showing signs of buoyancy, macro and inflation uncertainty are waning and the USD is rapidly losing its carry advantage,"
Lord believes the euro has the highest potential to outperform the dollar while expecting the British pound and Japanese yen to record negative returns for the year.
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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.