USD/JPY: Next move depends on the Fed, BofA

USD/JPY has been seesawing in a narrow range in the 151.000s over the last two weeks as threat of intervention from the Japanese authorities keeps bulls timid whilst stronger-than-expected US data keeps bears in check. 

The direction of USD/JPY’s next move has been the subject of much speculation but the factor that will be the most significant is the actions of the US Federal Reserve (Fed), according to Thanos Vamvakidis, Global Head of G-10 FX Strategy, Bank of America Merril Lynch (BofA). 

“To a large extent USD/JPY relies on the Fed. If the Fed does not cut rates it could go to 160.000, it does cut rates 142.000,” said Vamvakidis in an interview with Bloomberg News.  

If the Fed cuts rates in line with current expectations it will weigh on USD/JPY since it will reduce the advantage of keeping cash in US Dollars (USD) compared to Japanese Yen (JPY) from the point of view of the amount of interest that can be earned. 

Stronger-than-expected US data in recent weeks, however, has led some Fed policy makers to row back on promises to cut interest rates in the summer. Over the Easter weekend, Chairman Powell sounded more hawkish – meaning more in favor of keeping interest rates higher for longer – and the markets reacted by buying US Dollars. 

The probability of a first rate cut by the Fed in June has now fallen to just above 50% according to the CME FedWatch tool, from over 70% only a few weeks ago. At the start of the year the market was even pricing in a decent likelihood of a first rate cut in March. If the trend for “kicking the can” of interest rate cuts down the road continues, the timing of a first cut could get pushed back even further – to the autumn, winter or even next year.

BoJ out of the Picture 

The Bank of Japan (BoJ) on the other hand is unlikely to play a key role and Vamvakidis suggests it is unlikely the BoJ will rush to raise interest rates to combat rising inflation. Japan has the opposite economic problem to most of the rest of the world. 

“Japan is a completely different case – inflation there is a solution, not a problem. They are happy to see persistent inflation. It is above the target but not by much. And they have a long history of 30 years deflation.

“They will remain very cautious, leaning in the other direction compared to the other central banks,” said Vamavakidis. 

The Intervention Level

In March, Masato Kanda, Vice-Minister of Finance for International Affairs said the Yen had weakened beyond what market fundamentals warranted. He added that the Japanese Authorities would be ready to intervene if the Yen depreciated any further. From past experience of intervention, any level above 150.000 is considered a target for intervention. 

“I think 152 is a critical level at this point where we will expect intervention in a scenario where they do expect the Fed to start cutting this year. But if the market prices no cuts by the Fed this year they will realize the level is higher..” Said the Global Head of G-10 FX.”

Even if the authorities intervene, however, they won’t have the power to plug the levee forever, and it will eventually break, pushing USD/JPY higher.  

“It will be more like leaning against the wind. They know very well, also from the past, that these interventions don’t work, it is mainly a threat, so they can create some caution in the market, some two-way risk. 

“They know very well everything depends on the Fed. If they just buy some time with intervention until the Fed starts to cut rates it will be fine, but if the Fed does not cut this year then there is nothing these interventions can do.” Said Vamvakidis.