This morning, the USD/JPY pair has broken above the psychological level of 145. The Japanese government once again warned currency speculators of a possible intervention. Over the past few days, Tokyo has threatened several times to intervene in the currency market if the yen continues to slide. Will the Japanese authorities take action or will the verbal intervention be enough at this stage?
Why is USD/JPY rising?
By the end of the second quarter, the US dollar had strengthened against the yen by more than 8%. The main trigger for the USD/JPY pair was the stark contrast between the hawkish policy of the Federal Reserve (Fed) and the dovish stance of the Bank of Japan (BoJ).
This month, the US regulator refrained from raising the rate for the first time since March and kept it in the current range of 5.00%–5.25%. Yet, the regulator signaled the continuation of tightening in the future.
In June, its Japanese counterpart also kept rates at -0.1% and promised to stick to the ultra-loose policy in the near future.
Fears about the widening rate differential between the United States and Japan flared up this week. The statements of the heads of the Fed and BoJ at the European Central Bank (ECB) conference in Portuguese Sintra added fuel to the fire.
Last Wednesday, Fed Chair Jerome Powell said he expected two additional rounds of rate hikes in 2023 and also expressed concern that inflation in the country might remain above 2% until 2025.
BOJ Governor Kazuo Ueda, on the other hand, made it clear that the Japanese regulator does not intend to change its monetary policy this year and expressed doubts about the acceleration of prices in Japan.
The polar rhetoric of Jerome Powell and Kazuo Ueda gave the US dollar a new powerful driver and pushed it higher against the Japanese currency. This morning, USD/JPY reached an 8-month high at the level of 145.07.
Additional catalysts for the major currency were the latest hawkish comments from US officials, as well as the strong US macroeconomic data published yesterday.
Last Thursday, Fed Chair Jerome Powell participated in a conference organized by the Spanish central bank in Madrid. During his speech, he stated that the regulator is likely to resume rate hikes after the June pause.
This significantly increased the likelihood of tightening at the next Federal Reserve meeting, which will take place at the end of July. Currently, futures markets estimate it at 87% compared to 81% the day before.
The strengthening of hawkish trader expectations was also facilitated by American statistics. The weekly report of the Ministry of Labor showed that last week the number of initial jobless claims fell by 26,000 to 239,000. This is the largest decrease in 20 months.
Furthermore, the US Department of Commerce revised its GDP estimate for the first quarter. According to the updated estimates, the US economy expanded by 2% between January and March compared to the May estimate of 1.3% and the April reading of 1.4%.
"As we can see, economic growth in the US remains stable at the moment even despite the prolonged tightening of monetary and credit conditions in the country. This indicates that the Fed is likely to continue its aggressive policy," shared analyst Hugh Roberts.
A potential additional rate hike by the Fed is extremely negative for the yen, which is unlikely to receive hawkish support from the BoJ this year. Given the large divergence in the monetary policies of the US and Japan, many analysts see higher upside potential for the USD/JPY pair.
According to Bank of America, the US dollar may rise against its Japanese counterpart to 147 by September this year. However, some of their colleagues are not so optimistic.
There is an opinion that in the medium term, USD/JPY will continue to trade in the current price range of 144–145 even despite the July rate hike in the US. The rise will be limited by the growing risks of currency intervention from Japan.
What is the likelihood of intervention?
Today, USD/JPY may receive another boost. On Friday, the Fed expects the publication of its preferred inflation gauge – the core Personal Consumption Expenditures (PCE) price index.
Economists predict that in May the PCE index remained unchanged at 0.4% MoM and at 4.7% YoY. If their consensus is right, the Fed is likely to maintain its hawkish stance.
Logically, the dollar/yen pair should now be rising in anticipation of an important economic release, but at the time of writing, the major currency pair retreated from its intraday high of 145.07 and was trading around 144.7.
Pressure on the quote came from another warning from the Japanese government about possible market interventions. As soon as the pair crossed the 145 threshold early on Friday, Japan's Finance Minister Shinichi Suzuki immediately gave a speech.
The official once again stated that the Japanese authorities would be forced to respond appropriately to excessive yen exchange rate fluctuations.
The market is now afraid that the Japanese government could conduct two interventions in two weeks just as it did last year.
However, many analysts believe that at this stage, investors' fear of intervention is unfounded. In their opinion, this year Tokyo will limit itself to verbal warnings. Here are a few arguments that support this theory:
1.Intervention is very costly
Last year, Japan intervened in the market to strengthen the yen for the first time since 1998. Prior to this, authorities had repeatedly intervened with the opposite goal – to halt the rise of JPY, which could damage the export-dependent economy.
When Japan intervenes to prevent the yen from rising, the Ministry of Finance issues short-term bills, thereby increasing the cost of the currency, and then sells them to weaken JPY.
The process of strengthening the yen's exchange rate through intervention is much more complex and painful. For the rate to rise, authorities must use the country's foreign exchange reserves to exchange dollars for yen.
If Tokyo were to spend huge sums for buying currency every time it fell, Japan's monetary reserves would have long been depleted. Unlike JPY sell-off interventions, where Tokyo can essentially print yen in unlimited amounts, there is a certain limit here.
A record 6.35 trillion yen (about $43 billion) was spent on supporting the yen last year. Given this fact, we can assume that this year the authorities are unlikely to make a large-scale intervention again and may only hope for a small and temporary retreat of the USD/JPY pair.
2. No pressure from consumers
Throughout its history, the Japanese government has never decided to intervene to strengthen the yen during periods when the level of public dissatisfaction was low.
Any weak currency typically leads to an increase in the cost of living in the country, which naturally causes strong dissatisfaction among consumers.
This situation was observed in Japan at the end of last year when fuel prices and other commodities reached record highs, and the pace of the yen's depreciation accelerated significantly, undermining local purchasing power. Understandably, many were outraged, prompting the government to act.
Now, when inflation in the country remains above the target of 2%, but the effect of high energy prices has already subsided, public dissatisfaction is significantly lower than the critical levels of last year.
Based on this, it can be assumed that Tokyo currently has no compelling arguments to hit the red button again.
3. Relatively soft tone of threats
Over the last few days, the Japanese government has significantly intensified warnings about a possible intervention. However, this involves only an increase in the number of threats but not a change in rhetoric.
This week, Japanese officials continue to express concern about sharp movements in the foreign exchange market, each time warning of possible actions in response to excessive yen volatility.
In 2022, before carrying out actual intervention, the Japanese authorities had a much tougher tone. They used phrases such as "deeply concerned" and "decisive steps", which are absent in their latest statements
Given this, many analysts do not view recent warnings by Japanese authorities as a start of an actual intervention.
Conclusion
As we can see, the fundamental background continues to favor the rise of the USD/JPY pair. However, its future dynamics will largely depend on how traders perceive the risk of intervention.
If the market continues to believe the Bank of Japan, this could limit the upward movement of the pair in the short term. If, on the other hand, investors turn a blind eye to these warnings, the US dollar will likely continue its rally against the yen.