It’s the comeback currency.
The Japanese yen, among the world’s worst-performing major currencies in 2022, roared back to a seven-month high versus a now-reeling U.S. dollar on Friday, as traders bet the Bank of Japan will finally join other major central banks in tightening monetary policy.
A December reading Thursday on U.S. inflation that was in line with expectations “has allowed the FX markets to revert back to the main event — a potential sea-change in Bank of Japan policy and perhaps plenty of downside” in the dollar/yen currency pair, said Chris Turner, global head of markets at Dutch bank ING, in a Friday note.
“That is the hottest story in town right now,” he said.
Moreover, options traders are braced for the potential of a big move in the yen following next week’s Bank of Japan policy meeting, Turner said.
The U.S. dollar fell 3.2% last week to trade Friday at its lowest versus the Japanese yen USDJPY, +0.12% since May 30. With U.S. markets closed for the Martin Luther King Jr. Day holiday, the dollar rose 0.6% to 128.57 Japanese yen. The dollar has retreated more than 14% since topping the 150 yen level in October for the first time since 1990.
The dollar, which roared higher in 2022 as the Federal Reserve led a breakneck series of aggressive rate hikes in its effort to get a grip on inflation, has been in retreat since fall. The ICE U.S. Dollar Index DXY, +0.08%, a measure of the currency against a basket of six major rivals, was down 10.8% from a 20-year high set in October through Friday. What’s more, the index has retraced half of what it gained since bottoming on Jan. 6, 2021, noted Marc Chandler, chief market strategist at Bannockburn Global Forex, in a Friday note.
“The Japanese yen has led the move against the dollar, rising 2.8% this week amid heightened speculation that the Bank of Japan could take another step away from its easy monetary policy as soon as next week’s meeting,” he wrote.
The Bank of Japan shook global financial markets in December when it effectively loosened a longstanding cap on 10-year government bond yields, part of a policy known as yield-curve control. The surprise move was seen as potentially pointing the way to a broader tightening by the last major global central bank to maintain an ultraloose monetary policy, though outgoing BOJ Gov. Haruhiko Kuroda denied it was a precursor to tighter policy.
Global investors were rattled by the potential for the Bank of Japan to eventually give up its role as the last remaining low-rate anchor among the world’s major central banks.
Since then, the BOJ has faced more intense pressure to tighten policy. It’s decision in December allow the yield on the 10-year Japanese government bond TMBMKJP-10Y, 0.508% to trade as high as 0.5% versus a previous cap of 0.25% has emboldened traders to test the central bank.
The yield briefly rose as high as 0.545% in Asia on Friday. To halt the rise, the BOJ bought 1.8 trillion yen worth of JGBs with maturities from 1 to 25 years after it bought ¥4.6 trillion of JGBs Thursday, the largest daily amount of bond buying by the BOJ ever, The Wall Street Journal reported.
While the prospect of a shift in policy by the Bank of Japan is the primary driver of yen gains, there are other bullish factors to consider, said Steven Barrow, head of G-10 strategy at Standard Bank, in a Friday note.
“Economic recovery in China should prop up sentiment in Asia and should give the yen further support,” he wrote.
The course of the war in Ukraine will also be a driver, Barrow said. A lack of further escalation of the conflict would be supportive for the yen after Japan suffered a large terms-of-trade hit last year as energy prices soared following Russia’s invasion of Ukraine. Terms of trade is the ratio of a country’s export prices to import prices.
“Adverse terms of trade shocks usually lead to currency weakness in our view and we saw this not just for the yen but also for other hefty energy importers, such as the U.K. and the eurozone,” Barrow said. “If the more recent fall in energy prices sticks and these terms of trade-effects reverse, the yen should rise.”
The scope for yen strength is probably greatest versus the dollar, rather than currencies that could see their own terms of trade boost, like the euro EURJPY, +0.09% and the British pound GBPJPY, +0.08%, the strategist said, noting that Standard Bank’s 2023 yen target is ¥120.
Strategists cautioned that the BOJ might not have much to offer at its January meeting.
“Looking ahead at next week, the BOJ meeting on Jan. 18 will attract attention, though it’s quite likely it will result in inaction,” said Kit Juckes, global macro strategist at Société Générale, in a Friday note. “The details of the review into yield-curve control changes may, or may not, be released.”
That said, dollar/yen “remains the standout interest” in the FX options market, said ING’s Turner.
“One-week implied volatility remains at a very high 20% and volatility for the Bank of Japan meeting next Wednesday is priced as high as 40% or a near 1.7% move in spot USD/JPY,” or dollar/yen.
A 2% drop by the dollar/yen on Thursday showed that the FX options market may still be underpricing volatility, he said.
“This huge interest in USD/JPY is understandable. The BOJ may be on the verge of its biggest policy change in decades. Even short-dated JPY Interest Rate Swaps have started to move and are at the highest levels (near 30bp) since 2008!,” Turner said.
Traders are unlikely to want to stand in the way of dollar/yen downside, he said, leaving ¥126.50 as a clear-near-term target for dollar/yen.