Market Recap: Hopes of BoJ Hikes Saw Yen Falls Reverse

The Yen garnered year-end support from hopes that the Bank of Japan would raise interest rates, perhaps while the Federal Reserve was cutting its own. The currency’s fortunes in 2024 will depend on how these two prospects play out. It’s distinctly possible that both may be dashed, but the former looks more at risk.

The Japanese Yen has long suffered from the Bank of Japan’s position as a policy outlier. For decades the central bank has tried to stimulate domestic demand, and a bit more inflation, via the loosest monetary settings in the developed world. And it met with mixed success. However, the recent global inflationary wave didn’t leave Japan entirely unscathed. So, the Yen benefited from market hopes that even the BoJ might be tempted to join in the world trend toward higher interest rates. Back in July it went as far as tweaking its Yield Curve Control scheme, allowing ten-year local government yields to rise more strongly but still effectively capping them at 1%. Ever since the foreign exchange market has been wondering whether actual interest rate rises might follow, and this process has tended to support the Yen, even as the United States Federal Reserve looks as if it may have reached the top of its own rate-hike cycle. However, the BoJ has kept its base rate at minus 0.1% through 2023, and there seems little sign that it will be changing that policy in the first quarter of the New Year.

Key Drivers: Listen to the Fed, Watch Japanese Inflation

The ‘USD’ side of USD/JPY is likely to be where the real action is in the first three months of 2024. Markets are increasingly certain that US interest rates have peaked, and that the coming year will see reductions, possibly quite heavy ones. This thesis will tend to weaken the Dollar across the board, especially given that other major central banks are still intent on keeping their borrowing costs on hold at generational highs. Indeed, it’s far from certain that some have finished hiking, perhaps including the Bank of England. So, trading the Yen is likely to still mean in practice watching the Fed. For as long as those market hopes are realistic, the Dollar is likely to drift lower. As for the Bank of Japan, it's highly unlikely to make any policy shift unless there are clear signs of domestically driven inflation. As there are few of these at present and it will surely take more than a single quarter’s worth to prompt a BoJ move anyway. Yen traders should focus on Fed speakers as 2024 gets under way, and also on the monthly Japanese inflation data, with particular focus on domestically driven price rises.

What About the Carry Trade?

Given decades of miserable Japanese onshore returns, the Yen has been a favored carry trade currency, sold off to buy other units that offer better returns. A process that global rate rises have only accelerated. While lower US rates will likely see some unwinding of the popular Yen-into-Dollars carry, the bottom line is that those looking for yield are still likely to shun the Japanese currency.

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