This week, the foreign exchange market is witnessing something totally unusual. The Japanese yen that until recently has been called the main outsider among major currency pairs has suddenly advanced against the US dollar.
The USD/JPY pair turned to the downside on Wednesday when the US Fed announced another cycle of rate hikes. At its meeting in July, the US regulator raised the rate by 75 basis points for the second time in a row.
Actually, such a hawkish stance of the central bank should have pushed the greenback higher. Yet, exactly the opposite happened. It seems that the hint made by Jerome Powell about the rate approaching a neutral level was a limiting factor for USD.
This remark was a long-awaited signal for the market that the Fed may soon slow down the pace of monetary tightening. After these words, the US dollar depreciated across the board but the biggest losses were recorded against the Japanese yen.
Yesterday, the greenback managed to recover slightly (the US dollar index went up by 0.03%) but not against the yen.
On Thursday, USD/JPY continued its decline and tumbled by 1.74% to a 6-week low. This was the steepest fall of the pair since March 2020.
USD accelerated the pace of decline on the GDP data release in the US. The indicator came in worse than expected and put in question the further aggressive course of the Fed's policy.
According to preliminary estimates of the US Department of Commerce, the US economy shrank by 0.9% on year in the second quarter of 2022 after a 1.6% decline in the first three months of the year.
It is believed that the contraction of economic growth for the sixth straight month is a sign of a technical recession. Yet, US policymakers keep avoiding this term and claim that the recession has not started yet.
Meanwhile, the Bank of Japan's officials are worried about the potential downturn in the US and EU amid monetary policy tightening. Since Japan is highly dependent on global demand, a global recession poses a serious threat to its economy which is already affected by the aftermath of the COVID-19 crisis.
Unlike the US and Europe's economies, the economy of Japan is currently below the pre-pandemic level and may stay there throughout the year as recent estimates show.
So, it is hardly surprising that at its meeting in July, the Bank of Japan called for preserving stimulus measures and confirmed its course to keep interest rates at a minimum level.
For your reference, the divergence in the monetary policies of different central banks has strongly supported the dollar this year. Due to a wide gap between the US and Japanese 10-year government bond yields over the past 2 months, the US dollar was steadily rising against the yen and hit new record highs.
However, the latest Fed meeting raised doubts about the further policy of the central bank. Against this backdrop, the 10-year Treasury yield slumped from 3.5% to 2.6%.
This way, the gap has narrowed, thus canceling the upside momentum of the dollar/yen pair.
The greenback has been declining against the yen for the third session in a row. By now, it has retreated from a high reached in mid-July by almost 5%.
At the moment, USD/JPY is trading below the 50-day moving average around 134.28 which also acts as a key support level. According to Bloomberg analysts, this opens the way further to 130.
Yet, time will show whether the current uptrend in the yen may develop into a strong rally that derails the FX world's favorite short.
The change in interest rates largely depends on the macroeconomic data. There will be plenty of important publications ahead of the Fed's annual economic symposium in August that may influence the rhetoric of the US central bank.
Even a slightest hint during the symposium in Jackson Hole about the rate increase coming to an end will deliver a hard blow to the US dollar.