For an extended period, the yen was constrained by the considerable disparity between the Fed and Bank of Japan interest rates. However, in late July and early August, the currency managed to overcome this roadblock, triggering a significant market turmoil. Let’s discuss this topic and make a trading plan for the USDJPY pair.
The article covers the following subjects:
Highlights and key points
- The Bank of Japan may abandon policy normalization.
- The winding down of carry trades has caused turbulence in the markets.
- Increased volatility indicates that markets have not calmed down yet.
- The level of 147.2 is a line in the sand for the USDJPY pair.
Weekly fundamental forecast for Japanese yen
Everybody’s got a plan until they get punched in the face. Mike Tyson’s words quite accurately reflect the current state of the markets. Hedge funds and asset managers are closing short positions in the Japanese yen at the fastest pace since 2011. Not so long ago, they were at their highest level since 2007 but have fallen to their lows since February 2023. Even though the main reason for the turmoil in the financial markets was fears of a recession in the US economy, the sharp decline in the USDJPY also contributed to it.
Speculative positions on the Japanese yen
Source: Bloomberg.
While Donald Trump was insisting on the possibility of pressuring the Federal Reserve, the Bank of Japan faced significant challenges in late July. On the eve of the BoJ meeting, two prominent members of the Liberal Democratic Party, two of the ruling party’s most influential figures, engaged in a debate about the negative impact of the yen on the economy and suggested that an increase in the overnight rate might be necessary. The hawkish decision was subsequently adopted by a vote of 7 to 2. Kazuo Ueda was in the majority.
In 2000, Ueda was the youngest member of the Board of Governors and among the members who voted against raising borrowing costs. He was concerned about the potential market reaction. At that time, the BoE governor was correct in his assessment that the dot-com crisis and subsequent recession in the US economy forced the central bank to reduce the overnight rate. As history shows, Forex anticipated that a similar course of action would be required in August, namely, the abandonment of the previous normalization step to calm the markets. The Bank of Japan opted for an alternative approach. The regulator stated that it would not extend the current monetary restriction cycle if market turbulence persisted.
The yen’s elevated volatility points to the continued unease among investors. This has resulted in an unwinding yen-based carry trade and a decline in the USDJPY quotes. TS Lombard estimates that carry traders will have to find $1.1 trillion to repay their Japanese currency-denominated debts. JP Morgan believes that 75% of the trades have already been closed, while Morgan Stanley cites a figure of 60%. These are carry trade operations in which the yen was involved.
Carry trade strategy efficiency
Source: Bloomberg.
The return of market stability has also led to a decline in USDJPY. Bears anticipate a reduction in the divergence between the monetary policies of the Fed and the Bank of Japan, a decline in the number of carry trade transactions, and an increase in demand for the yen as a risk-hedging instrument. BNY believes that together with the undervaluation of the yen, these factors will eventually bring down the US dollar to ¥100.
Weekly USDJPY trading plan
As for now, bulls are taking advantage of Donald Trump’s influence and the notable divergence in the policies of the Federal Reserve and the Bank of Japan. If US inflation data exceeds expectations, the pair is likely to soar. On the contrary, the USDJPY pair may decline on disappointing figures. The level of 147.2 offers a critical threshold, which determines whether the pair should be bought or sold.
Price chart of USDJPY in real time mode
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