In light of the robust economic performance and rising inflation, the BoJ’s monetary tightening cycle should be maintained. While this is positive for the Japanese yen, there are some negative aspects to consider. In particular, the current political uncertainty is a significant factor. Let’s discuss these issues and make a trading plan for the USDJPY pair.
The article covers the following subjects:
Highlights and key points
- The appointment of a new prime minister may extend the BoJ’s wait-and-see approach.
- Accelerating GDP and inflation require BoJ to raise rates.
- The divergence in monetary policy is beneficial for the Japanese yen.
- Short trades can be opened as long as the USDJPY pair is trading below 147.2.
Weekly fundamental forecast for Japanese yen
Political uncertainty is definitely the factor the Japanese yen wishes to avoid. In addition to speculating on whether the Bank of Japan will raise rates again in 2024 and experiencing fluctuations in economic performance, the resignation of Prime Minister Fumio Kishida has caused significant concern among investors. Some of the candidates have expressed criticism of the weak yen and urged the Bank of Japan to support the national currency. Will their influence on the central bank trigger increased volatility in the USDJPY pair?
In the context of political uncertainty, the optimal approach is to temporarily postpone adjustments to monetary policy. As anticipated, the derivatives market has reduced the probability of a continuation of the normalization cycle in 2024 from 63% in early August to 29%. AllianceBernstein projects that the BoJ will only raise the overnight rate from its current 0.25% if the USD/JPY exchange rate returns to 160.
Japanese government bond yield change and BoJ rate hike expectations
Source: Bloomberg.
It would be unwise to underestimate the BoJ. Despite speculation that the July decision to raise the overnight rate was influenced by political pressure, the circumstances dictate the need for monetary policy normalization. Kazuo Ueda stated that the economy and inflation must grow in line with forecasts for the cycle to continue. The conditions are favorable for these projections to become a reality.
Japan’s GDP expanded by 0.8% on a quarterly basis and 3.1% on an annual basis in the second quarter. On a quarterly basis, the previous period’s loss of 0.6% was fully recovered. Concurrently, consumption is expected to recover further due to the effects of a one-time cut in income and property taxes. According to Capital Economics, the positive dynamics of gross domestic product and consumer spending will increase the BoJ’s confidence that the economy can withstand higher interest rates. This provides an excellent rationale for raising them further, particularly given the recent market stability.
Japan’s economy performance
Source: Bloomberg.
The Bank of Japan will likely view the persistence of inflation as further justification for maintaining the normalization cycle. Bloomberg expert forecasts indicate that consumer prices increased from 2.8% to 2.9% year-over-year in July, while core inflation rose from 2.6% to 2.7% year-over-year. These indicators have remained above the target benchmark of 2% for over two dozen months, with the BoJ constrained only by the economy’s weakness. However, this constraint has now been lifted.
Weekly USDJPY trading plan
The divergence in the monetary policy of the Fed and the BoJ justifies selling the USDJPY pair. However, the markets are overly optimistic about the scale of the federal funds rate cut in 2024, so the US dollar will unlikely depreciate as expected. Against this backdrop, it is better to stick to the previous strategy, which implies that short trades can be opened as long as the pair is trading below 147.2.
Price chart of USDJPY in real time mode
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