Forex
Will Fed rate cuts really be negative for USD/JPY?
Investing.com — The potential impact of U.S. Federal Reserve rate cuts on the pair is a critical issue for investors and currency strategists, particularly as we approach a possible Fed pivot in 2024.
With divergent monetary policies between the Fed and the Bank of Japan (BoJ), market participants are divided on whether Fed rate cuts will lead to a weaker USD/JPY.
As per analysts at BofA, the relationship between Fed rate cuts and USD/JPY is more nuanced, with a variety of structural and macroeconomic factors playing a role.
Contrary to common market expectations, the relationship between Fed rate cuts and a weakening USD/JPY is not a given.
Historically, USD/JPY did not always decline during Fed easing cycles. The key exception was during the 2007–2008 Global Financial Crisis (GFC), when the unwinding of the yen carry trade caused significant yen appreciation.
Outside of the GFC, Fed rate cuts, such as those seen during the 1995–1996 and 2001–2003 cycles, did not lead to a major decline in USD/JPY.
This suggests that the context of the broader economy, particularly in the U.S., plays a crucial role in how USD/JPY reacts to Fed rate moves.
BofA analysts flag a shift in Japan’s capital flows that dampens the likelihood of a sharp JPY appreciation in response to Fed rate cuts.
Japan’s foreign asset holdings have shifted from foreign bonds to foreign direct investment and equities over the past decade.
Unlike bond investments, which are highly sensitive to interest rate differentials and the carry trade environment, FDI and equity investments are driven more by long-term growth prospects.
As a result, even if U.S. interest rates decline, Japanese investors are unlikely to repatriate funds en masse, limiting upward pressure on the yen.
Moreover, Japan’s demographic challenges have contributed to persistent outward FDI, which has proven to be largely insensitive to U.S. interest rates or exchange rates.
This ongoing capital outflow is structurally bearish for the yen. Retail investors in Japan have also increased their foreign equity exposure through investment trusts (Toshins), and this trend is supported by the expanded Nippon Individual Savings Account (NISA) scheme, which encourages long-term investment rather than short-term speculative flows.
“Without a hard landing in the US economy, Fed rate cuts may not be fundamentally positive for JPY,” the analysts said.
The risk of a prolonged balance sheet recession in the U.S. remains limited, with the U.S. economy expected to achieve a soft landing.
In such a scenario, the USD/JPY is likely to remain elevated, especially as Fed rate cuts would likely be gradual and moderate, based on current forecasts.
The expectation of three 25-basis-point cuts by the end of 2024, rather than the 100+ basis points priced in by the market, further supports the view that USD/JPY could remain strong despite easing U.S. monetary policy.
Japanese life insurers (lifers), who have historically been major participants in foreign bond markets, are another key factor to consider.
While the high cost of hedging and a bearish yen outlook have led lifers to reduce their hedging ratios, this trend limits the potential for a JPY rally in the event of Fed rate cuts.
Furthermore, lifers have scaled back their exposure to foreign bonds, with public pension funds driving much of Japan’s outward bond investment.
These pension funds are less likely to react to short-term market fluctuations, further reducing the likelihood of a yen appreciation.
While BofA remains constructive on USD/JPY, certain risks could alter the trajectory. A recession in the U.S. would likely lead to a more aggressive series of Fed rate cuts, potentially pushing USD/JPY down to 135 or lower.
However, this would require a significant deterioration in U.S. economic data, which is not the base case for most analysts. Conversely, if the U.S. economy reaccelerates and inflation pressures persist, USD/JPY could rise further, potentially retesting 160 in 2025.
The risk from BoJ policy changes is considered less significant. Although the BoJ is gradually normalizing its ultra-loose monetary policy, Japan’s neutral rate remains well below that of the U.S., meaning Fed policy is likely to exert a greater influence on USD/JPY than BoJ moves.
Additionally, the Japanese economy is more sensitive to changes in the U.S. economy than the reverse, which reinforces the notion that Fed policy will be the dominant driver of USD/JPY.
Investing.com – The US dollar has rallied strongly since the US Presidential election, from an already high level, and Bank of America Securities sees the currency now priced to perfection.
In real effective terms, BoA estimated that the dollar ended 2024 at a 55-year high, following the longest uptrend in recent decades, which started in mid-2011.
“The USD has also reached extreme levels in nominal terms. Using the BIS NEER broad index (nominal effective exchange rate), the USD is the strongest it has been in the last 30 years, which is when the time series started,” said analysts at BoA Securities, in a note dated Jan. 8.
The dollar appears overvalued by 18.5%, the most in the last 30 years except when it was overvalued by 19% during the energy shocks from the war in Ukraine in 2022, the bank said.
Its overvaluation increased by about 6.4% since the end of Q3 last year, to a large extent because of the US election. By comparison, it was overvalued only by 9.4% at the end of 2016, after Trump won his first US election.
Looking at G10 equilibrium estimates, the USD clearly stands out as the most overvalued – followed by CHF, with JPY and the Scandies being the most undervalued.
“We expect the USD to remain strong in the short term on the back of US inflationary policies, and particularly tariffs, but to weaken later in the year, as these policies take a toll on the US economy while the rest of the world responds. Policy uncertainty makes our baseline subject to substantial risks,” said BoA Securities.
Investing.com – The US dollar rose Wednesday, benefiting from rising bond yields after the release of healthy US economic data, while weak German industrial orders weighed on the euro.
At 04:35 ET (09:35 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.3% higher to 108.690.
Dollar gains as Treasury yields soar
The dollar has continued to push ahead Wednesday, following on from the prior session’s positive tone after data showed US unexpectedly rose in November, layoffs were low, while services sector activity accelerated in December and a measure of prices paid for inputs hit a two-year high.
This resulted in 10-year Treasury yields climbing to an eight-month high, while the benchmark 30-year yield came close to the 5% level.
“Yesterday’s US data releases were hawkish for the Fed, and the implied probability of a March rate cut has now dropped below 40%,” said analysts at ING, in a note.
“The most remarkable print was the ISM prices paid subcomponent, which spiked to the highest level since January 2023. If a generally resilient economy was already accounted for when the Fed met in December, a resurgence in inflation concerns could drive an even further hawkish tuning in the policy message.”
The Federal Reserve cut the number of rate cuts it sees this year to two at its December meeting, but traders are now only pricing in around 37 bps of easing through this year, according to LSEG data.
There is more data to digest Wednesday, in the form of the monthly and weekly , ahead of Friday’s release of the closely watched US for further clarity on the health of the world’s largest economy.
German economic weakness weighs on euro
In Europe, fell 0.2% to 1.0326, adding to the losses of around 0.5% overnight after the release of more disappointing economic data from the region’s largest economy – Germany.
fell 5.4% in November, sapped by a decline in large orders, while the country’s fell 0.6%, bursting hopes for a boost from pre-Christmas promotions like Black Friday and Cyber Monday.
Investors are currently looking for the to ease interest rates by around 100 basis points in the first half of 2025.
“There is only a speech by French central bank governor Villeroy to watch in the eurozone calendar today. EUR/USD may find decent support at 1.0300 for now,” said ING.
traded 0.2% lower to 1.2447, with little in the way of economic data due for release Wednesday, and only a speech from Bank of England Deputy Governor Sam Woods to digest.
The held interest rates unchanged last month, and is expected to proceed cautiously with further rate cuts this year with inflation still above target.
Yuan sentiment remains weak
In Asia, rose 0.1% to 7.3511, with the Chinese currency hitting its weakest level in 17 years earlier in the week.
Sentiment remains weak surrounding China ahead of President-elect Donald Trump’s inauguration on Jan. 20, with Trump having vowed to impose steep trade tariffs on China.
gained 0.1% to 158.19, after recovering marginally from its weakest level in nearly six months.
The yen stemmed its recent losses after government officials offered a verbal warning on potential currency market intervention, which saw traders adopt more caution in shorting the Japanese currency.
By Tom Westbrook and Greta Rosen Fondahn
SINGAPORE/GDANSK (Reuters) -The dollar rose for a second day on Wednesday on higher U.S. bond yields, sending other major currencies to multi-month lows, with a report that Donald Trump was mulling emergency measures to allow for a new tariff program also lending support.
The already-firm dollar climbed higher on Wednesday after CNN reported that President-elect Trump is considering declaring a national economic emergency as legal justification for a large swath of universal tariffs on allies and adversaries.
The was last up 0.5% at 109.24, not far from the two-year peak of 109.58 it hit last week.
Its gains were broad-based, with the euro down 0.43% at $1.0293 and Britain’s pound under particular pressure, down 1.09% at $1.2342.
Data on Tuesday showed U.S. job openings unexpectedly rose in November and layoffs were low, while a separate survey showed U.S. services sector activity accelerated in December and a measure of input prices hit a two-year high – a possible inflation warning.
Bond markets reacted by sending 10-year Treasury yields up more than eight basis points on Tuesday, with the yield climbing to 4.728% on Wednesday.
“We’re getting very strong U.S. numbers… which has rates going up,” said Bart Wakabayashi, Tokyo branch manager at State Street (NYSE:), pushing expectations of Fed rate cuts out to the northern summer or beyond.
“There’s even the discussion about, will they cut, or may they even hike? The narrative has changed quite significantly.”
Markets are now pricing in just 36 basis points of easing from the Fed this year, with a first cut in July.
U.S. private payrolls data due later in the session will be eyed for further clues on the likely path of U.S. rates.
Traders are jittery ahead of key U.S. labour data on Friday and the inauguration of Donald Trump on Jan. 20, with his second U.S. presidency expected to begin with a flurry of policy announcements and executive orders.
The move in the pound drew particular attention, as it came alongside a sharp sell-off in British stocks and government bonds. The 10-year gilt yield is at its highest since 2008. [GB/]
Higher yields in general are more likely to lead to a stronger currency, but not in this case.
“With a non-data driven rise in yields that is not driven by any positive news – and the trigger seems to be inflation concern in the U.S., and Treasuries are selling off – the correlation inverts,” said Francesco Pesole, currency analyst at ING.
“That doesn’t happen for every currency, but the pound remains more sensitive than most other currencies to a rise in yields, likely because there’s still this lack of confidence in the sustainability of budget measures.”
Markets did not welcome the budget from Britain’s new Labour government late last year.
Elsewhere, the yen sagged close to the 160 per dollar level that drew intervention last year, touching 158.55, its weakest on the dollar for nearly six months.
Japan’s consumer sentiment deteriorated in December, a government survey showed, casting doubt on the central bank’s view that solid household spending will underpin the economy and justify a rise in interest rates.
hit 7.3322 per dollar, the lowest level since September 2023.
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