Over the last week, the rise in the USDJPY has stalled out, which could be crucial ahead of key data on Friday.The Bank of Japan has said it will be data dependent, and inflation is the most important information for a central bank. So, the upcoming release could be the defining point for whether the yen makes another run at 160, or it has already peaked.
The catalyst for the currency pair has been the resurgent strength in the dollar following the election of Donald Trump. With the Fed expecting to cut less through the course of the next year, the interest rate gap between the dollar and yen is projected to remain wide. That makes it an interesting bet for carry trading. In fact, since the US election, there has been a surge in foreign buying in Japanese treasury markets, as investors look to take advantage of a potentially weaker yen.
Setting the House in Order
Japanese authorities are having trouble responding to the situation, because they are being bogged down with different views on how to address the problem. It’s understood that the loss in popularity of the ruling party is because of financial issues in the country. The weaker yen causes imported goods to cost more, which affects consumers directly in a country like Japan that must import most of its fuel and a large amount of its food.
On the other hand, Japan is an export nation, meaning that its overall economy benefits from a weaker yen. If Japanese authorities step in to support the currency and push it back towards the 100 level, it would essentially plunge the nation into a recession. Which would make the government even more unpopular. So, two factions have developed: The “hawks” and “doves”.
The Options for The Bank of Japan (BOJ)
The doves want to let the currency run its course and support consumers with domestic spending. This would be in the form of stimulus spending, which brings to mind China’s measures to support its own economy. Japan’s problems also stem from China, as it exports a lot of machinery to the Asian giant. Carry traders are betting on the doves, since that would weaken the currency, as The Bank of Japan (BOJ) would keep rates really low.
The hawkish position isn’t to strengthen the yen, rather not let it fall, bringing interest rates back up in line with the rest of the world. That would involve cutting spending by the central government in order to alleviate the domestic inflationary pressures in hopes of offsetting the effects of the weaker yen.
What Can the BOJ Do?
With the government still unable to pick which side it wants to take, the BOJ has to wait before formulating a response. That is an explanation for Governor Kazuo Ueda’s remarks on Monday, not providing any guidance for whether there will be a rate hike. Instead, he said the bank would look very closely at the data. If inflation remains elevated, then the BOJ will have to move to raise rates regardless of the relative hawkishness or dovishness of the government. But, if inflation continues to fall, then it could generate even more ambiguity about what will happen with rates. With carry traders being relatively skittish, a stronger print than expected in the CPI data could turn the yen around, pushing the USDJPY on a downward course.
Headline October Japanese CPI change is expected to come at an annual rate of 2.2%, down from 2.5% prior. That’s above the BOJ’s 2.0% target. The “core-core” rate, on the other hand, is expected to remain relatively flat at 2.0% compared to 2.1% prior.
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