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Yen Eyes Gains vs Dollar, BOJ Moves Key to Fall Below 150

Yen eyes further gains against dollar amid US-Japan yield gap narrowing and diverging monetary policies.

By Athena Xu

5/16, 17:04 EDT

Key Takeaway

  • Yen's strength against the dollar tied to US-Japan yield gap, with potential for further gains if BOJ reduces bond purchases.
  • Diverging monetary policies and cooling US inflation fuel expectations of a narrower yield gap, supporting yen appreciation.
  • Market anticipates possible BOJ rate hike in June; yen undervalued by almost eight yen, with Fed policy easing required for significant gains.

Yen's Weekly Gain

The Japanese yen is on track for another weekly gain against the dollar, marked by its most significant one-day rally in two weeks on Wednesday. This performance comes without any apparent intervention from the Bank of Japan (BOJ). The yen's future movement, particularly its potential to strengthen toward 150 from its current position around 155, is closely tied to the US-Japan yield gap. This relationship is expected to become clearer with upcoming financial indicators, particularly with the next significant data point anticipated on Friday.

The spread between US and Japanese two-year yields has seen a narrowing of almost 30 basis points in May to about 4.46 percentage points. This change is attributed to diverging monetary policy outlooks between the two nations. In the US, yields have decreased due to a dovish Federal Reserve, slower job gains than expected, and cooling core inflation, which collectively have fueled expectations for rate cuts. Conversely, the BOJ's decision on Monday to reduce bond purchases for the first time since late December has pushed two-year yields to their highest since 2009.

Yield Gap's Influence

The US-Japan yield gap's narrowing to levels last seen in January and February, when the dollar-yen traded below 150, underscores the significant impact of yield differentials on currency strength. The upcoming week's light US data agenda suggests that any further narrowing of this gap may primarily result from actions on the Japanese side. Market participants are divided on whether the BOJ will announce further reductions in its bond-buying program on Friday, with a potential surprise cut possibly exerting additional downward pressure on the dollar-yen exchange rate. It's noteworthy that the BOJ owned 54% of outstanding Japanese government debt at the end of 2023.

Market Perspectives

Analysts and traders are closely monitoring the dynamics between US and Japanese monetary policies and their implications for the dollar-yen exchange rate. The possibility of the BOJ bringing forward a small rate hike to its June meeting could mark a bullish turning point for the yen. Additionally, the current slide in 1-year US OIS to levels associated with a 150 handle on the USD/JPY suggests further potential for a downward shift in the exchange rate.

The yen's valuation, currently seen as undervalued by almost eight yen, reflects significant market dynamics. While a tactical rally in Treasuries could support the yen in the short term, a more substantial adjustment toward its fair value would require convincing evidence of a continued slowdown in US inflation, potentially leading the Fed to start easing policy. However, any rapid strides in the yen's appreciation would likely hinge on signs of deterioration in the US labor market.