How will the Yen defend its gains?

The US dollar continued its retreat against a backdrop of easing geopolitical risks and the return of the ‘sell America’ trade, which was popular during the trade wars. Distrust of US policy has grown following coordinated currency intervention. An insider report in the Wall Street Journal is adding fuel to the fire, claiming that Donald Trump is in regular contact with Kevin Warsh. If the new Fed chair is a puppet of the White House, the greenback is in for a rough ride.

Oman and Iran are close to striking a deal to reopen the Strait of Hormuz without charging a fee. But this requires action from the US. Most likely, this involves the lifting of sanctions. As a result, oil supply will increase, leading to a fall in prices. The risks of accelerating inflation will diminish, and with them the likelihood of the Fed tightening monetary policy. This will allow other currencies to strengthen against the US dollar.

Will the yen be an exception? According to Bank of America, USDJPY will plummet to 149 by the end of the year, as the Bank of Japan will be forced to accelerate its monetary policy tightening to maintain the currency pair’s current levels. A policy of ‘acting in September rather than waiting until October’ will help strengthen the yen.

By contrast, CBA forecasts a rally in USDJPY to 165 by the second quarter of 2027. By that time, the Bank of Japan will have raised its overnight rate only twice. The Fed, meanwhile, will tighten monetary policy three or four times, starting in December.

A resurgence in carry trades could put pressure on the yen. Due to coordinated currency intervention, the Bloomberg EM FX Carry Risk Premia Index fell by approximately 1%. In 2024, Japan’s interventions in the forex market resulted in a 4% slump in the index. Carry traders were prepared for such a scenario and had diversified their portfolios. They are now gradually returning to selling the yen as a funding currency, anticipating a slow normalisation of the BoJ’s monetary policy.

The fate of USDJPY remains in the hands of the central banks. Meanwhile, US employment data for July will influence all dollar pairs. A strong labour market will increase the likelihood of a Fed rate hike and support the greenback. Conversely, a cooling labour market will help the yen. 

Summary: The yen is dependent on the actions of the BoJ and the Fed: support from the Bank of Japan will strengthen it, but carry trades and strong US data could put pressure back on USDJPY.