USD/JPY to face explosive volatility as BOJ intervention looms

Yesterday, the dollar received hawkish momentum from the Fed, propelling the USD/JPY pair to a new 10-month high of 148.47. This significantly heightens the risk of currency intervention from Tokyo. Traders now fear that Japanese authorities might defend the yen as early as tomorrow, especially if it weakens further against the dollar following the dovish decision by the Bank of Japan. Let's delve into whether these concerns are justified.

The US currency is on track for its longest rally in nearly a decade, with the dollar now set for its tenth consecutive week of gains.

Yesterday, DXY strengthened against a basket of major currencies, reaching 105.59, its highest level since March. The catalyst for the greenback's boost was the US Federal Reserve meeting, which was interpreted as hawkish.

The Fed didn't surprise the markets with another interest rate hike. As anticipated, the regulator kept the rate steady at 5.25%–5.50% but hinted at further tightening.

The updated dot plot from the FOMC indicates that US policymakers still expect additional rate hikes this year that will bring the rate to a peak range of 5.50%–5.75%.

This suggests that the Fed is contemplating another round of tightening in November or December, given stable inflation and continued economic strength.

Another tailwind for the dollar came in the form of the FOMC's improved interest rate trajectory for 2024. Earlier, officials expected a rate cut of 100 basis points from the anticipated peak by the end of the following year, but now they project a reduction of only 50 basis points.

This consensus bolsters the market's belief that US interest rates will remain high for a considerable duration. Such a perspective bodes well for the greenback, aiding its long-term growth trend.

Regarding the short-term dynamics of USD, the majority of analysts foresee the continuation, and even strengthening, of the bullish trend.

"The recent rally in the US dollar index led to the formation of a so-called Golden Cross - a bullish chart pattern that reaffirms a positive outlook for the currency in the foreseeable future," strategists from BofA noted.

Experts believe that due to the market's hawkish sentiments, the greenback will continue its upward trajectory across the board in the coming days, with the most promising dynamics potentially being demonstrated against JPY.

The fact that the Federal Reserve shows no signs of retracting its hawkish monetary policy stance and may raise rates even further has ignited traders' concerns regarding the continued strong monetary divergence between the US and Japan.

It's worth noting that the Bank of Japan (BOJ) remains the only major global regulator that continues to disregard high inflationary pressures and maintains a dovish stance, characterized by ultra-low interest rates.

However, a recent hawkish remark from BOJ Governor Kazuo Ueda took many by surprise. In an interview with the Yomiuri newspaper, he suggested that by year-end, Japan might confirm a favorable wage growth cycle, a preliminary condition for rate hikes.

Market participants are now eagerly awaiting what the Japanese policymaker will convey at the BOJ's monetary policy meeting set for tomorrow.

"Traders are hoping to get hints on whether Ueda's hawkish comment was an indication of an impending policy normalization in Japan or if the official was merely trying to prop up the weakening yen," noted Bloomberg Economics analyst, Toru Fujioka.

If the Kazuo Ueda provides clear signals on Friday about an imminent monetary policy shift, it would substantially bolster the yen and push the USD/JPY pair downward.

However, if Ueda reaffirms the BOJ's intention to adhere to a dovish policy trajectory in the foreseeable future, the yen might weaken even more against the dollar. Most analysts surveyed by Bloomberg anticipate this scenario.

According to their perspective, the Japanese regulator will maintain its status quo this month, signaling the need to stick to a dovish policy until confident in stable inflation, backed by wage growth.

Should the experts prove accurate, it will likely trigger another wave of volatility in the USD/JPY pair, which might culminate in dire consequences for dollar bulls.

In the overnight session leading up to Thursday, the implied volatility in the USD/JPY pair surged to its highest level since July 28. The last time such sharp fluctuations were observed in USD/JPY was when the Bank of Japan took the market by surprise by adjusting its yield curve control.

Now, the spike has happened in the opposite direction, inevitably sparking speculations about a potential Japanese intervention, especially as Tokyo has once again issued warnings to speculators.

Just a day ago, Japan's top currency diplomat Masato Kanda voiced his concerns, and today, it was echoed by the Chief Cabinet Secretary of Japan, Hirokazu Matsuno.

Both officials emphasized that the government is closely monitoring market movements and will take appropriate measures if there is an abrupt depreciation of the yen.

While these may sound like routine statements, traders do have a genuine reason to be concerned this time. Kanda emphasized in his speech that Japanese authorities are in daily close contact with their US counterparts regarding exchange rate fluctuations.

The following day, US Treasury Secretary Janet Yellen affirmed this, stating that Tokyo's desire to smooth market volatility is understandable.

Some experts believe Yellen's comment suggests that the US might support a Japanese intervention this time.

If this is indeed the case, we might witness another Japanese market intervention tomorrow.

Notably, the first of the two interventions carried out in 2022 by Tokyo was initiated exactly a year ago on September 22.

Concerns about the intervention are heightened by the fact that the yen is currently trading about 1% below the 150 level against the dollar, which many regard as the so-called "red line."

If the USD/JPY pair crosses this threshold in the short term (a very high likelihood given dovish analysts' forecasts regarding the BOJ meeting), Tokyo is unlikely to remain uninvolved. Traders are hence advised to brace for potential high volatility.

Technical indicators on the daily chart remain firmly within positive territory and are still far from the overbought zone. This bolsters bullish sentiment, indicating that the pair is set to trade upwards.

In the near term, buyers are likely to see strengthening upward momentum beyond the 148.45 zone before placing new bets. A subsequent upside move may propel the quote towards the next significant resistance around the 148.80–148.85 area, paving a swift route to the pivotal 149.00 mark.

Beyond that, momentum could extend towards the 149.70 area, above which the bulls would target the psychologically significant level of 150.00, last tested in October 2022.

On the flip side, a decisive break below 147.50 could trigger some technical selling of the asset, pushing it back towards the 147.00 mark. Following that, the quote might decline to the horizontal support at 146.50 before potentially plummeting below the 146.00 mark.