Japanese Yen struggles despite rising bond yields and BoJ hike bets

USD/JPY rebounds on Monday after coming under selling pressure earlier in the day, as the Japanese Yen (JPY) struggles to gain traction despite a weaker US Dollar (USD). At the time of writing, the pair trades around 159.25, recovering from an intraday low of 158.85.

The Yen struggles despite the recent joint intervention by Japan and the United States and a rise in Japanese government bond yields to multi-decade highs. The intervention briefly pushed USD/JPY toward 155.00, but the pair has since recovered most of that decline.

Japanese yields are climbing as a weaker Yen and elevated energy prices worsen the inflation outlook. Yen depreciation raises import costs, particularly for energy, at a time when tensions in the Middle East and restricted shipping through the Strait of Hormuz are keeping Oil and gas prices elevated. Japan relies heavily on imported energy, leaving the economy exposed to rising global prices.

Against this backdrop, the Bank of Japan (BoJ) is expected to raise interest rates as early as September. The benchmark 10-year Japanese government bond yield touched 2.93% on Monday, its highest level since 1996.

Higher interest rates and bond yields would normally support the Yen by making Japanese assets more attractive and narrowing the yield gap with other major economies. However, they also raise concerns about Japan’s fiscal outlook. With the government carrying a heavy debt burden, sustained higher yields would gradually increase borrowing and debt-servicing costs, limiting their positive impact on the currency.

Weaker-than-expected Japanese growth data add another challenge for the BoJ. Preliminary Gross Domestic Product (GDP) expanded 0.3% QoQ in the second quarter, below the 0.5% forecast and the previous 0.5% increase. Annualized growth slowed to 1.1%, missing expectations of 2.0% and easing from 1.8%.

The softer data highlight the difficult balance the central bank faces. Raising interest rates could support the Yen and limit imported inflation but would also increase borrowing costs and place additional pressure on the economy and bond market. Keeping policy accommodative could ease pressure on bonds but risk additional Yen weakness.

Meanwhile, the US Dollar stays under pressure as recent US economic data point to weaker labour demand, softer consumer spending and easing inflation. Traders now expect the Federal Reserve (Fed) to keep interest rates unchanged in September, reversing earlier expectations of a hike.

The risk of another round of currency intervention also discourages buyers from pushing the pair decisively higher, keeping USD/JPY capped below the 160 psychological mark.