Monetary policy divergence is perhaps the strongest driver of the Forex exchange rate, other things being equal. And traders are well aware of this. They forgot about the armed conflict in Ukraine for a while and began to actively buy USDJPY, armed with different views of the Fed and the Bank of Japan on the fate of interest rates. As a result, the dollar soared 9% against the yen in three weeks, reaching its highest level since 2015. Are the bulls exhausted or do they still have gunpowder in their flasks to restore the upward trend?
It just so happened that investors are trying to predict the further actions of the Central Bank on various signals. According to the speeches of FOMC officials or the actions of the Bank of Japan. The latter's intention to defend by all means the target level of 0.25% on the yield of 10-year bonds made it clear that the regulator is not going to abandon the ultra-soft monetary policy. It can be understood. Firstly, when your country is sitting on a mountain of debt at 259% of GDP, the rising cost of servicing it does not bode well. Secondly, after the acceleration of prices in Tokyo, Haruhiko Kuroda and his colleagues had the opportunity to achieve the inflation target throughout Japan. There hasn't been such a chance for a long time. Why not use it?
Theoretically, widening the yield differential between the U.S. and Japanese bonds should lead to a flow of capital from Asia to North America, which provides a comfortable advantage for the USDJPY bulls.
Dynamics of USDJPY and the yield differential of U.S. and Japanese bonds
At the same time, a further widening of the spread in debt rates looks unlikely. Currently, the futures market believes in a 50 basis points increase in the federal funds rate in May. Derivatives signal that it will hit the 2% mark by the end of 2022. Against the background of an increase in non-agricultural employment in the U.S. by 431,000 and a fall in unemployment to 3.6% in March, this looks quite logical. However, monthly U.S. wage growth is slowing, a harbinger of a slower rise in consumer prices. In any case, it's hard to imagine the Fed acting even more aggressively than investors are now expecting of it.
The Bank of Japan, in turn, is unlikely to want to expand monetary stimulus. Further weakening of the yen could lead to significant side effects, including for the government. Local households face the challenge of rising electricity bills, which is directly related to the weakening of the national currency and the increase in the cost of imports. Ultimately, the USDJPY rally may turn into a political issue, forcing the Central Bank to use verbal interventions.
Technically, there is no doubt about the strength of the USDJPY upward trend, however, the risks of the formation of the Splash and Shelf pattern are growing. This allows me to recommend using a consolidation trading strategy. We sell the dollar in case of an unsuccessful test of resistances at 123.3 and 124 and buy it in case of a rebound from the supports at 122.1 and 121.65.
USDJPY, Daily chart