The Japanese yen(USDJPY) hit something of a milestone this week which is in line with its trend since the start of the year. The currency pair fell below the psychologically important 150 handle, which it had bounced off of back in December of last year. But whether it will continue further likely relies on a complex array of fundamental factors.
Of course the main feature here is the BOJ, which will hold its next rate decision in the middle of next month. There is near unanimity in expectations that there won’t be a change in rates then. But the sensitivity of the yen to moves in interest rates is such that small changes in the odds of a rate cut in July are likely to move the currency pair.
The Move So Far
Rising expectations that the BOJ will once again tighten by a quarter of a percentage point around the middle of the year have contributed to the recent strength in the yen. What’s also affecting the currency pair is some additional weakness in the dollar over the last couple of weeks as investors try to figure out what’s happening with tariffs.
One of the main reasons why the Japanese yen(USDJPY) is particularly vulnerable to volatility is the amount of carry trade that it has been subjected to. Carry traders respond to expectations for moves in interest rates at a faster rate than other investors who might be buying into a currency to, for example, fund stock purchases.
Interest Rates vs Inflation
Of course what carry traders care about is the difference in interest rates paid on debt in the respective currencies. They borrow with low interest rates (in this case, yen), sell that currency to buy another with higher interest rates (in this case, the dollar). As long as the difference in interest rate remains attractive (that is, more than they can get in interest rates in something else, like US treasuries), then the currency pair will be weaker.
If the BOJ raises rates, then that gap narrows. If the Fed cuts rates, the gap narrows as well. The other complicating factor is inflation. In the case of carry trade, where there is both a borrowing and a loaning side to the equation, then the difference of inflation can be important. Higher inflation in Japan is seen encouraging borrowing there; while higher inflation in the US will discourage lending in dollars.
Hitting the Bounce
That’s why traders are being so keenly focused on Japan and the US inflation rate when it comes to the USDJPY. It’s not just because the central banks will raise or lower rates in reaction to moves in the CPI. As the largest city in Japan, Tokyo’s CPI is largely seen as predictive of where the numbers for the whole country are going. That’s why Friday’s data release could get extra attention given the price for the Japanese yen(USDJPY) and the uncertainty about the timing of the next rate hike (whether June or July).
Markets are anticipating that the core CPI for the Tokyo area will decline to 2.4% from 2.5% prior. That would likely leave July as the most likely time for a hike. But if it were to instead rise, the market might start pricing in an earlier rate hike. In turn, this could give the USDJPY an bounce instead of a continuation.
