Yen is recovering – The most volatile currency on FX

In the FX market, high volatility could appear on several pairs simultaneously, or selectively on one currency. Currently, the title of the most volatile major currency seems to be taken by the Japanese yen, and fluctuations on JPY-linked currency pairs seem to be the greatest in the past weeks.

To get an idea of the magnitude of the changes taking place on the USD/JPY pair, for example, it is worth recalling that back at the beginning of the year, 100 yen had to be paid for a dollar. Meanwhile, a month ago, the dollar already cost almost 140 yen, which means a 40% increase in the rate in just over six months. Then, the USD/JPY exchange rate reached its highest level since 1998.

Importantly, in the case of Japan, we are not talking about the economy of a developing country or one mired in political or economic crisis, but about one of the world's leading economies. The rally in the USD/JPY exchange rate seemed to stem from the divergence in the monetary policy pursued by the US Federal Reserve and the Bank of Japan. The Fed strenuously tightens the monetary policy, while the Bank of Japan resists any increases in interest rates, including bond yields, and continues to buy their unlimited quantities.

However, while the Bank of Japan's policy maintains its course, the market started to play against a possible turn in the Fed's actions. This could reduce the spread in the U.S. versus Japanese bond yields and lead to a strong turnaround in the USD/JPY exchange rate. The yield difference between 10-year U.S. Treasury securities and the corresponding Japanese debt held near its lowest level in nearly four months at around 245 basis points, which could weaken the dollar's appeal.

In early August, the dollar was around 131 yen, and it took only three weeks to move from around 140 yen. This is a relatively large change for the currencies of the world's major economies. As a result, the U.S. dollar has fallen to its lowest level in more than six weeks against the Japanese yen, and investors appear to be increasing bets that the Federal Reserve's aggressive monetary policy could drive the economy into recession.

Traditional market indicators of recession (such as the yield curve) appear to be falling to their lowest levels this year. Investors seem to be increasingly confident that US interest rates will peak by the end of 2022 - according to data from the federal funds rate futures market. This could lead to a potential weakening of the US dollar.