What’s next for the US dollar/yen after BoJ’s rate cuts?

>> What is the outlook for the US dollar/yen?

While defending the yen was clearly not the BoJ’s priority, the persistent fall in the currency leaves the Ministry of Finance – and the BoJ - with a headache. But what can the authorities do if the yen continues to slide?

US dollar/yen has followed the classic “buy the rumour, sell the fact” script in recent weeks. The yen first rallied to 147 against the US dollar as speculation of an imminent rate hike by the BoJ gathered momentum, and then unwound all this strength and more by falling to near-152 last week; a level that’s not been seen since 1990.

The Ministry of Finance (MoF) is clearly unhappy at the yen’s slide as Finance Minister Suzuki stepped up the rhetoric by insisting that the authorities are watching the situation very closely. The implicit assumption from this might be that the BoJ will intervene again, just as it did in September 2022 to try to pull US dollar/yen down. That intervention seemed to work but another rally in US dollar/yen saw this152 level almost reached again just over a year later, in October 2023.

With two failures to clear 152 in the last two years, US dollar/yen bulls must now be wondering whether it is third time lucky for them, and third time unlikely for the MoF and BoJ. For the danger now is that the US dollar could rally substantially if 152 is cleared and perhaps especially if the BoJ tries, and fails, to halt the US dollar in its tracks.

As we see it, the Japanese authorities face two main challenges. The first is that the hike in policy rates was very small at 10-bps and it will take much higher rates still for the yen-funded carry trade to fall out of favour. The second problem is that expectations for rate cuts in the US have been scaled back and this too keeps the carry trade alive. If we take each of these in turn; a yen-funded dollar carry trade has returned more than 50% in the past two-and-a-half years. That’s a strong return compared to the rather barren period since the global financial crisis when policy rates in both countries were close to zero for the most part.

The BoJ could lift rates much more and faster but that would seem to jar with its domestic aims and hence it won’t do that. But even if it did, we tend to find that big reversals in carry trades don’t normally happen because the central bank in the funding currency country lifts policy rates; it usually happens because some sort of global disaster strikes causing investors to ditch higher-yielding currencies and buy back the funding currency (the yen in this case). Japanese policymakers might want a stronger yen but clearly won’t want one that results from some sort of disaster.

>> Reason for the US dollar’s rise against major currencies

Another problem for the BoJ is that the important policymaking decisions are out of its hands; they belong to the Fed. If the Fed is cautious with its rate cuts, or perhaps does not cut at all, US dollar/yen could still rally whatever the BoJ does with rates or FX intervention. The MoF could ask for the Fed’s help with any FX intervention but that’s unlikely to be well received given Japan’s trade position and the fact that volatility in the yen is low; in fact, almost as low as it has been in two years, suggesting that there’s not a pressing need for intervention.

So, what is likely to happen? Given that the market has made two attempts to vault 152 on dollar/yen and failed we suspect that the dollar bulls have a strong incentive to try again as a break of this level could result in a sharp dollar rally. Hence a break seems likely. But will it lead to a dramatic rise in the US dollar? We are not so sure. While we doubt that the BoJ will try to defend the 152 region with intervention, the bank might allow the bulls to be lulled into thinking that US dollar/yen can skyrocket on a break of this level and then try to hit the market hard some distance above the 152 level. In short, we would not argue that US dollar/yen looks a good buy in the 152 region; in fact, over the long haul, it is more likely to prove a good level to sell.