During last week’s trading sessions, the US dollar dominated the currency market. As the US financial year ended, the dollar index rose +8%. It finished the week modestly stronger against Asian currencies. However, the greenback was largely driven by technicals and hopes of a Fed pivot. As a result, EUR/USD, GBP/USD and USD/JPY pair were under pressure.
In the US, the US CPI report was softer than expected. However, the Philadelphia Fed Manufacturing Index slid to a negative -19.4 from -8.7 in September. This prompted markets to refocus on lower-yielding currencies. Despite this, the dollar managed to edge higher against the yen. This resulted in the USD/JPY pair breaking through its ascending trend channel for the first time in over a year.
The US CPI report had the potential to sway Bank of Japan hawks who want to call off large-scale monetary easing. Meanwhile, Japanese PPI showed mixed results. However, the national CPI was expected to turn into positive territory. The Bank of Japan is expected to continue to maintain its ultra-loose monetary policy. The BOJ remains the only major central bank with negative interest rates. However, this may change in the coming months. Whether this leads to a stronger USD/JPY remains to be seen.
Japan’s economy has substantial internal tensions. The country’s FX reserves are not unlimited. This means that Japan’s large firepower can only be employed so far. Moreover, small and medium sized businesses can’t escape the grip of inflation. In addition, Japan’s older voters have fixed incomes and cannot export without inflation. The Japanese government encourages businesses to boost wages. But while this is a welcome relief for consumers, it also helps offset a cost of living crisis.
The Bank of Japan has been an outlier for the last year. Despite maintaining its ultra-loose monetary policy, the yen has declined 22% against the dollar in the last 12 months. The Bank of Japan has spent $70bn on FX intervention between the USD/JPY region 146-151.
The Japanese yen also surged against the US dollar on soft US CPI. The BOJ is hoping that prices will rise to a level that will justify its stance of zero interest rates. It will also continue to maintain its yield curve control target of -0.10%. However, this may not last long. Increasing prices could lead to inflation that peaks after hitting 3%.
The Bank of Japan’s hawks want to free Japan from its monetary isolation. However, Japan’s economic outlook is still vulnerable to stagflation. Despite a modest increase in inflation, the economy is expected to grow just 1.2% in the year ahead. Moreover, Japan’s older voters have fixed incomes after decades of deflation. Moreover, the Bank of Japan has staked everything on beating deflation.
The yen’s strength against the dollar helped boost exports. However, the yen’s strength against the US dollar may be short-lived. The Bank of Japan’s persistent monetary policy may also erode the USD/JPY pair. In addition, the Bank of Japan may continue to use its large FX reserves to support the currency.