The USDJPY is trading in a compressed range amid contradictory fundamental pressures. Recent dollar strength has caused the pair to rise, bringing in quick warnings from Japan’s Ministry of Finance. Traders are monitoring the 160 level as a potential psychological barrier that could prompt action by policymakers.
A shift in the underlying fundamental landscape could be the catalyst to break the pair out of the range. Japan’s Finance Ministry could hold off on intervention if the currency pair is moving on fundamentals instead of speculation, allowing a move higher. On the other hand, if the yen strengthens on upcoming data, then the subsequent unwind of carry trades could push the pair well below its current range.
What’s Keeping the USDJPY From Moving?
The wide interest-rate differential between the BOJ and the Fed makes borrowing in yen to buy dollar-denominated debt very attractive, putting upward pressure on the currency. However, the threat of intervention keeps traders from pushing it above 160, leaving the pair trading within a tight range.
The main issue for the yen is the interest rates, with both the Fed and the BOJ seen as hawkish. If there are signs that the interest rate gap will close, the yen could gain, but if the gap widens, the pair would likely rise. The market is pricing in that both central banks will hold pat, keeping the interest rate divide as is. This means that fluctuations in the currency are likely to depend on variations in the yields of their respective bonds.
Markets Move Contrary To Data
Following last week’s hot US CPI data, US bond yields rose, with the natural consequence being a rise in USDJPY as well. However, the gains were short-lived, and the bond market reversed itself fairly quickly. Headlines pointed to Fed Chair Kevin Warsh’s comments at the IMF Summit on Friday as the cause of the retracement in US yields. However, the move lower happened long before he started speaking.
Interestingly, the odds of a Fed rate hike at the upcoming meeting didn’t change appreciably after the hotter-than-expected inflation figures. This suggests that the market has baked in a pause in October and a December hike by the Fed. Long term yields have not risen in accordance with the data, implying that markets are seeing it as more likely the Fed will reach a lower terminal rate.
What the Market Is Looking For
This is particularly relevant for Japan because the market seems to be pricing in continued gradual rate hikes by the BOJ. In other words, the market expects the interest rate gap to close over the long term, making carry trading less profitable and riskier. This could keep a lid on the USDJPY, particularly if the upcoming data continues to pressure the BOJ to hike in December and thereafter.
Japan’s trade balance is released early Wednesday and is expected to show a significant narrowing of the deficit to -¥270 billion from -¥1.11 billion a month earlier. The focus will likely be on the difference between imports and exports, as higher import prices are seen as pushing up consumer prices. On the other hand, a rebound in exports could bolster demand for the yen and imply faster economic growth, allowing the BOJ to remain hawkish.
