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.
Bank of America (BofA) analysts indicated that the prevailing bearish sentiment on Eastern Europe, Middle East, and Africa (EEMEA) foreign exchange (FX) is nearing its peak, particularly noting an exception for the Turkish lira (TRY).
According to BofA’s proprietary flow data, there is a record high in long positions on the U.S. dollar against emerging market (EM) currencies, which the analysts interpret as a contrarian signal that EM and EEMEA FX could soon start outperforming expectations, potentially beginning from February or March.
The report highlighted several currencies in the EEMEA region with a bullish outlook. The Polish zloty (PLN) is expected to strengthen due to a combination of a weaker dollar, a hawkish stance from Poland’s National Bank (NBP), and positive current account and foreign direct investment (FDI) inflows. The South African rand (ZAR) is also seen as bullish, with its undervaluation against the dollar poised to correct in a weaker USD environment.
In Turkey, the analysts are optimistic about the lira, citing tight monetary policy that supports adjustments in the current account, which should benefit the currency. Their forecast for the TRY is significantly more favorable than current forward rates.
The Israeli (ILS) has a neutral outlook from BofA, with predictions aligning with forward rates for the second quarter of 2025. However, they acknowledged potential upside risks for the shekel if ceasefire deals in the region are fully implemented.
For the Czech koruna (CZK), the report suggests that the currency is likely to perform better than forward rates indicate, as the Czech National Bank (CNB) is expected to be cautious with its easing cycle in the short term, and a weaker dollar should provide additional support.
Lastly, the Hungarian forint (HUF) is anticipated to gain strength from the second quarter onwards, bolstered by credible new central bank leadership and fiscal policy, alongside the influence of a weaker USD.
This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.
Investing.com – The US dollar drifted lower Wednesday amid uncertainty over President Donald Trump’s plans for tariffs, while sterling fell on disappointing government borrowing data.
At 04:45 ET (09:45 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.1% lower to 107.755, after a slide of over 1% at the start of the week.
Dollar slips on tariffs uncertainty
The dollar remained on the backfoot as traders tried to gauge the full extent of President Donald Trump’s plans for tariffs, and the potential pain the new administration plans to inflict on major trade partners.
Trump said late on Tuesday that his administration was discussing imposing a 10% tariff on goods imported from China on Feb. 1, the same day as he said Mexico and Canada would face levies of around 25%.
He also indicated that Europe would also suffer from the imposition of duties on European imports, but has refrained from enacting these tariffs despite signing a deluge of executive orders following his inauguration on Monday.
“Data will play a secondary role this week as all the attention will be on Trump’s first executive orders,” said analysts at ING, in a note. “Incidentally, the Federal Reserve is in the quiet period ahead of next Wednesday’s meeting. Expect a lot of ‘headline trading’ and short-term noise, with risks still skewed for a stronger dollar.”
Sterling falls after retail sales dip
In Europe, traded 0.1% lower to 1.2349, after data showed that Britain ran a bigger-than-expected budget deficit in December, lifted in part by rising debt interest costs.
was £17.8 billion pounds in December, more than £10 billion pounds higher than a year earlier, the Office for National Statistics said on Wednesday.
Rising UK government bond yields have added to the cost of servicing the country’s debt, and could result in the new Labour government having to cut government spending to meet its fiscal rules.
edged higher to 1.0429, but the single currency remains generally weak with the European Central Bank widely expected to cut interest rates more consistently this year than its main rivals, the Federal Reserve and the Bank of England.
The is seen cutting interest rates four times in the next six months, with a reduction next week largely expected to be a done deal.
“The direction is very clear,” ECB President Christine Lagarde told CNBC in Davos about interest rates. “The pace we shall see depends on data, but a gradual move is certainly something that comes to mind at the moment.”
BOJ meeting looms large
In Asia, dropped 0.1% to 155.69, ahead of the Bank of Japan’s two-day policy meeting later this week.
The is widely expected to raise interest rates on Friday, and could reiterate its commitment to further rate hikes if the economy maintains its recovery.
traded largely unchanged at 7.2715, with the Chinese currency still weak after Trump said he is considering imposing 10% tariffs on Chinese imports from Feb. 1.
Investing.com – Volatility in the US dollar following contradictory signals around the Trump administration’s plans for tariffs suggest that, at least in some ways, Trump’s second term will probably resemble the first, according to Capital Economics.
Tuesday’s sharp selloff in the US dollar followed reports that the many executive orders the new president would go on to sign didn’t include any immediate increase to US tariffs. A few hours later the greenback rebound after Trump suggested he will bring in 25% tariffs on China and Mexico in February.
“The first, and most obvious, point is that this is unlikely to be the last such episode over the second Trump presidency,” said analysts at Capital Economics, in a note dated Jan. 21, “with this pattern of leaks and counters familiar from the 2018-19 US-China trade war.”
“As was the case back then, uncertainty around Trump’s intentions will probably result in plenty of short-term volatility in currency markets.”
One key implication of these moves is that some expectations of higher tariffs are by now discounted, Capital Economics said.
Positioning data suggest that market participants are heavily long dollars, on net, increasing the scope for sell offs when there is dollar-negative news, whether on account of tariffs or other reasons.
It’s harder to make the case that expectations around tariffs have been the biggest driver in currency markets over recent months, or that higher US tariffs are anywhere close to fully discounted.
Instead, we think the main driver of the stronger dollar has been more prosaic: the rebound in US economic data since the Q3 recession scare, combined with bad news in Europe and China, has led to a shift in interest rate differentials in favor of the US.
That said, our working assumption remains that Trump will enact major tariffs on China later this year, “which is why we forecast the to be one of the worst-performing currencies this year.”
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