Since the March FOMC meeting, upward pressure on USDJPY has been strong. USDJPY rose above 120 for the first time in six years as the divergence between the Fed and Bank of Japan (BoJ) becomes more apparent. A pause is probably overdue after the dramatic surge. But history suggests that there is no clear pattern in subsequent moves. USDJPY can just as easily extend its upside or retrace. We favour an overshoot of USDJPY to 125 in 6 to 12 months’ time and have revised our 3/6/12-month USDJPY targets to 123/125/125 respectively.
We see three reasons for the extension of the USDJPY uptrend. First, widening US-Japan yield differentials driven by the contrast between a hawkish Fed versus a dovish BoJ could drive USDJPY higher. Fed Chair Powell cemented the idea that the Fed will do whatever it takes to restore price stability, including 50bp moves and the need to catch up to a more neutral policy stance. Higher energy prices following Russia’s invasion of Ukraine raises risks of higher inflation and slowing growth. But greater US energy independence relative to other major economies provides scope for the Fed to do what it takes to get inflation under control without having to overly worry about recession risks.
By contrast, BoJ is likely to remain dovish. BoJ governor Kuroda acknowledged the possibility of Japan's CPI temporarily reaching 2% on higher oil prices. April’s CPI is also likely to jump well above 1% as last year’s mobile phone fee cuts fall out of the year-on-year calculation. This may cause the market to think about earlier BoJ rate hikes this year. But we expect the BoJ to look through the temporarily higher inflation rate, as underlying inflation is likely to stay muted given anaemic wage growth.
Hawkish Fed versus a dovish BoJ could drive USDJPY higher
Source: Bloomberg, Bank of Singapore.
Second, the JPY’s failure to strengthen not just against the USD but also on a broader basis highlights the increasing drag from higher commodity prices for a commodity importing currency like the JPY. Higher for longer energy prices could worsen Japan’s trade deficit and undo the current account surplus to the detriment of the JPY.
Third, challenges to JPY as a safe haven currency is likely to linger. The ability of the JPY to hedge a portfolio of riskier assets during recent risk-off episodes has been disappointing. This comes down to central bank policies. While the BoJ remains dovish, major central banks – even the European Central Bank for now – have turned hawkish in response to higher inflation. This in turn means that JPY-crosses may not perform very well as safe havens for now.
We continue to favour JPY as a funder of choice relative to the EUR. We find it difficult to envisage the JPY outperforming other than during extreme risk-off phases that are accompanied by sustained funding strains similar to that witnessed during the initial stages of the COVID-19 pandemic. We are mindful that the JPY’s cheap valuation, as well as BoJ personnel changes - which include two less dovish members joining in July and BoJ governor Kuroda’s term expiring in April 2023 - are risks that could reverse the uptick in USDJPY. But it is not clear these risks will matter just yet.
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