USD/JPY reaches monthly high, threatens breakout on USD “impregnability”

The USD/JPY inches back up towards the April highs at 154.79 on Monday after a de-escalation in Middle East tensions reduces safe-haven flows to the Japanese Yen (JPY). This affects the JPY more than the US Dollar (USD), despite both holding safe-haven status.

The conflict between Israel and Iran has not escalated in the way markets feared. After Israel’s one-off attack on a military base outside Isfahan on Friday, Iran has not counter-attacked. As a major safe-haven, the JPY has seen demand fall and continues its long-term trend of depreciating against USD. 

USD/JPY at risk from risk

Although hostilities in the Middle East have temporarily subsided, the threat of outbreaks in the future are an ever present risk. 

Geopolitical risks have not completely dissipated and a division appears to be opening up in the world between the West and what Gideon Rachman, Chief Foreign Affairs Commentator for the Financial Times, calls an “axis of adversaries”. These include Russia, Iran, North Korea and China.  

Rachman points out that the military base outside Isfahan targeted by the Israelis in Friday’s attack, is in fact, a nuclear enrichment site which utilizes Chinese-supplied reactor technology.

A further outbreak of hostilities or general ratcheting up of geopolitical risk factors is likely to see safe-havens like the JPY rise, with bearish implications for USD/JPY. 

War is not the only potential source of geopolitical risk that could pressure USD/JPY. Reports of a fresh strain of the Omicron variant of the Covid-19 virus have also destabilized markets at the start of the new week. 

“While the WHO is urging caution, it noted that symptoms linked to the new strain so far have been mild.  Because it will take some time to determine the likely impact on the global economy, we believe risk aversion will continue this week,” say analysts at private investment bank Brown Brothers Harriman in a note on Monday. 

A handful of countries have already introduced minor social distancing measures, but if the strain begins to spread and pose a more serious health risk, this could present a fresh risk factor for investors, leading to a steady stream of funds into safe-havens, favoring the Japanese Yen above all. 

USD/JPY traders could come out on Friday 

Friday April 26 stands out as a big day for USD/JPY as it is then that the Bank of Japan (BoJ) will hold its April policy meeting and the US will publish Personal Consumption Expenditure (PCE) data for March, including the Federal Reserve’s (Fed) preferred gauge of inflation, the Personal Consumption Expenditure – Price Index. 

If PCE inflation in the United States (US) registers a higher-than-expected rise it will boost USD/JPY, by suggesting an even longer delay before the Fed reduces interest rates. If interest rates remain higher for longer it increases demand for USD from foreign investors looking to park their capital. 

Likewise if the BoJ increases interest rates at its meeting or drops clues it intends to in the near future, the JPY will appreciate (pushing down USD/JPY). 

BoJ unlikely to raise interest rates, chance of policy tweak

Amongst institutional analysts the consensus expectation is that the BoJ will not raise interest rates until October. 

“We expect the Bank of Japan to keep its short-term rate target unchanged (range 0-0.1%), after hiking the policy rate for the first time in 17 years in March. Going forward, we expect the BoJ to keep a modest, gradual hiking path,” said ABN Amro. 

Deutsche Bank sees a risk the BoJ will “remove its JGB purchasing guidelines from its statement or revise them to make its purchasing operations more flexible,” – a move which could support the Yen. 

Despite seeing another hike as unlikely, many Japanese officals think the US Dollar’s recent ascent has gone too far and something needs to be done to support the Yen. 

“Ongoing yen weakness (partly driven by the pricing out of Fed rate cuts) means that there is an increasing probability that the BoJ may consider to come with the next rate hike earlier than the current consensus expectation of October 2024 (as indicated by market pricing),” says ABN Amro, adding that against this backdrop, Governor Ueda may try to verbally intervene by dropping clues about future tightening. 

Last week, the finance ministers of both Japan and South Korea acknowledged “serious concerns about the recent sharp depreciation of the Japanese Yen and the Korean Won.” The Bank of Indonesia went further and intervened to stabilize its slumping currency, according to analysts at Brown Brothers Harriman (BBH). 

USD impregnability? “It’s hard to find reasons to bet against..USD”

The US Dollar is currently basking in the glory of an almost bullet-proof US economy. Apart from PCE inflation data on Friday, proof of further US economic success could come in other macro data out on Tuesday and Wednesday. 

“Overall, as long as US economic activity remains solid, the cyclical USD uptrend is intact. The US preliminary April PIs (Tuesday), Q1 GDP (Thursday) and March Personal Income and Outlays report (Friday) are expected to back American economic exceptionalism,” says BBH in a note on Monday. 

USD/JPY bears could be facing an uphill struggle given the US Dollar’s perceived impregnability. 

“It is hard to find any reasons to bet against the Dollar,” said Michael Pfister, FX Analyst at Commerzbank in an interview with Bloomberg News. “We have seen an appreciation in the Greenback over the last two weeks on the back of an inflation surprise. On top of that we have a strong growth advantage and a very hawkish Fed,” added the analyst. 

On Friday the trend of Federal Reserve members becoming more cagey about when they might start cutting interest rates gained further momentum. Chicago Fed President Austan Goolsbee hinted at a longer timeline for interest rate cuts as progress on inflation had “stalled”, adding inflation has significantly dropped from its pandemic-era peak of 9.1%, but remains stubbornly above the Fed’s target. Meanwhile, Atlanta Fed President Raphael Bostic noted that the US central bank wouldn’t cut rates until the end of the year, according to Lallalit Srijandorn, an Editor at FXStreet.