Fed in USD/JPY driver’s seat – SocGen

Alvin T. Tan, Research Analyst at Societe Generale, suggests that short of direct market intervention, the BoJ is running out of policy options for getting the yen back on a weakening trend.

Key Quotes

“The growth of the real rate spread in determining the yen’s direction means that BoJ policy now needs to directly drive Japanese inflation expectations higher to weaken the yen, and that is a tall order given the persistence of disinflation/deflation pressures in Japan. Fiscal stimulus could help support growth but is questionable as a policy tool to weaken the currency. On the contrary, in conventional economic models, fiscal stimulus would be expected to contribute to a stronger currency through higher real rates, all else being equal.

What this suggests is that the direction of USD/JPY has come to depend largely on higher US dollar nominal and real rates. In other words, the BoJ has become dependent on a hawkish Fed to push USD/JPY back onto an appreciation trend. While we do see USD/JPY rising towards 120 in the coming quarters due to Fed tightening, we do not expect new cycle highs given the BoJ’s loss of control. Thus, USD/JPY at 120 or higher, perhaps from rising expectations of further Fed tightening, would present a selling opportunity.”