USD/JPY grinds higher on US exceptionalism, weak Japanese data

USD/JPY is trading up two-tenths of a percent in the 155.80s on Thursday as the US Dollar (USD) continues its recovery rally from the May 3 lows. 

The strength of the Dollar is broad-based although USD/JPY is rising faster than the US Dollar Index (DXY) – perhaps because the Japanese Yen (JPY) is depreciating more than most currencies following the release of weak wage data from Japan.

A lack of inflationary pressures in Japan means the Bank of Japan (BoJ) cannot raise interest rates to support the Yen. This, combined with the outlook for higher interest rates in the US due to strong economic activity, suggests a bullish outlook for USD/JPY. 

Everything is relative 

The most recent comments from Federal Reserve (Fed) officials suggest they are in favor of keeping interest rates higher for longer due to stubbornly high inflation. This is one of the factors supporting the Greenback, as higher interest rates strengthen a currency because they generate greater foreign capital inflows. 

Another factor supporting the USD is the divergence that the Fed’s stance opens up with other major central banks.  

“The relative story continues to push the (US) Dollar higher. Given the absence of any topline US economic data, we chalk these gains up to developments in the rest of the world. With FX, it’s always about the relative story and here, other central banks have so far shown an unwillingness to be as hawkish as the Fed. First, the RBA delivered a neutral hold.  Then, the Riksbank delivered a 25 bps cut, becoming the second major central bank to cut rates (after Switzerland).  Who’s next?” Says Brown Brothers Harriman in a note on Thursday. 

Since this was written, the Bank of England (BoE) has reported a dovish hold, with two board members dissenting – up from one last time – and voting for a rate cut instead. The decision sent GBP/USD lower and the Pound Sterling (GBP) depreciated against the USD. 

US growth is sound

The expectation the Fed will need to keep interest rates higher for longer is backed not just by “jawboning” but by a relatively strong outlook for US growth. 

US economic growth in Q2 remains robust according to various nowcasting models that give real-time estimates for growth. 

“The Atlanta Fed’s GDPNow model is tracking Q2 growth at 4.2% SAAR and will be updated next Wednesday after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q2 growth at 2.2% SAAR and will be updated tomorrow,” says BBH. 

The models suggest continued inflationary pressures from economic activity which will further delay the decision to cut interest rates, keeping demand robust for USD. 

Japanese Yen hampered by weak data  

USD/JPY’s bullish outlook is further encouraged by a debilitated JPY which remains handicapped by poor data.

Japan nominal Cash Earnings data in March came out well below estimates at 0.6% year-over-year (vs.1.4% forecast) and below the previous month’s 1.5%. Real Cash Earnings, meanwhile, fell 2.5% YoY when a drop of 1.4% had been expected and a fall of 1.8% was registered in February. 

The data was the weakest reading for real Cash Earnings since November and suggests very little in the way of wage pressures. 

Given the BoJ’s focus on trying to raise wages to escape the deflation spiral the data suggests, “the BOJ’s tightening process will be gradual,” according to BBH. 

“..we doubt the BOJ will tighten more than is currently priced-in (30bps of hikes in 2024). First, underlying inflation in Japan is in a firm downtrend..” Says BBH. 

As many analysts have already pointed out, unless the Japanese authorities can combine direct intervention to prop up the Yen with interest rate hikes they do not have the firepower to beat market forces and USD/JPY will continue to rise. 

As such, Bank of Japan’s Governor Kazuo Ueda’s recent warnings that a policy response might be needed if foreign exchange rates affect the inflation trend, seem like a hollow threat because he does not have the data behind him to back up his words with actions.