The BoJ’s September rate hike marks an extraordinary shift in monetary policy. Japan hasn’t embarked on such a rapid tightening cycle since 1990. Back then, Japan was viewed as a major economic threat to the United States. Now, the country has clearly moved away from its previous ultra-loose monetary policy framework. Let’s examine what this shift means for the Japanese yen and develop a trading plan for the USD/JPY.
The article covers the following subjects:
Major Takeaways
- The Bank of Japan intends to raise interest rates.
- The BoJ’s primary objective is to avoid making the situation worse.
- The Japanese government is not opposed to monetary tightening.
- Short trades can be opened if the USD/JPY pair drops below 154.4.
Weekly Fundamental Forecast for Yen
Japan is transforming from a sleeping economic giant into an increasingly attractive destination for investment. Will the Bank of Japan’s monetary tightening help or hinder this process? Markets are confident the overnight rate will rise from 1% to 1.25% at the September 17–18 Board of Governors meeting and assign an 80% probability of further tightening by year-end. If realized, this would represent the fastest pace of monetary tightening since 1990. Back then, tightening sent stock indices tumbling and contributed to a prolonged period of stagnation. Today, monetary policy normalization is attracting capital and supporting gains in Japan’s major stock indices, including the Nikkei 225 and TOPIX.
BoJ Overnight Rate and TOPIX
Source: Bloomberg.
The expected rate hike would be the third in 10 months—something Japan hasn’t seen since the period when the country was viewed as a threat to US economic dominance. Under Kazuo Ueda, the BoJ has tightened monetary policy six times, more than under any other central bank governor in the past half-century. Higher borrowing costs alone seem unlikely to send Japanese stock indices tumbling. In 1990, forward P/E ratios soared to around 70, signaling an extreme valuation. Today, the Nikkei 225 trades at a P/E ratio of around 21, while the TOPIX stands at approximately 17.
As a result, Prime Minister Sanae Takaichi can arguably rest easy. Like Donald Trump, she has shown concern about stock market performance. If the market can absorb higher interest rates, then why not raise them? This is especially true given the substantial gap between bond yields and borrowing costs, which suggests that the Bank of Japan is behind the curve and has been slow to normalize monetary policy.
Spread Between 2-Year Japanese Bond Yields and BoJ Policy Rate
Source: Bloomberg.
In theory, the Bank of Japan could afford to take its time. At first glance, the 1.8% inflation rate seems to be the main argument for doves on the Board of Governors. However, government energy subsidies are helping keep prices in check. At the same time, Brent crude rising above $100 per barrel and a weak yen could push CPI inflation above 3%.
Therefore, the BoJ’s main task is to avoid undermining the progress it and the government have made in driving USD/JPY lower. If markets are pricing in an overnight rate hike to 1.25%, the BoJ may need to deliver it—and signal that further monetary tightening remains on the table. The catch is that it takes two to tango. The USD/JPY’s direction depends not only on the BoJ but also on the Fed, and the latter will deliver its verdict first.
Weekly USDJPY Trading Plan
In this connection, traders should consider several scenarios. Hawkish rhetoric from the Fed and a neutral stance from the Bank of Japan would create a favorable backdrop for adding to long positions established at 154.4. Aggressive monetary tightening by both central banks could trigger a roller-coaster ride in the USD/JPY, with selling on upswings. Conversely, disappointment with the Fed could create an opportunity to sell the US dollar against the yen near 154.4. In this case, Kazuo Ueda’s speech may no longer matter.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of USDJPY in real time mode
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