Narrowing interest rate differentials between Japan and the rest of the world has been a key theme in the outlook for the Japanese yen to improve in the past two weeks. The main USD/JPY pair fell to five-week lows on Tuesday, before bouncing back to trade in the green at the time of writing, while yen pairs such as the CAD/JPY, which have been falling more sharply due to Trump’s plans to impose tariffs on Canada’s exports to the US, remained in the red. The yen has also shown relative strength against other commodity dollars as well. Pairs such as AUD/JPY and NZD/JPY remained on the defensive.
Expectations of a rate hike by the Bank of Japan support the Japanese yen outlook
With this week’s rate hike taken into account almost completely, could this latest decline in USD/JPY provide an opportunity to buy when falling down, or will we see a more decisive uptrend for the yen?
With yield spreads between the US and Japan hitting five-week lows, the USD/JPY pair followed. However, with inflation risks rising due to potential large-scale tariffs, the pressure of the latter yield may approach its limit, you might think. Thus, for USD/JPY to fall more clearly, we will need to see a rate hike by the Bank of Japan this week, or a significant deterioration in US data.
Yesterday, there was initial optimism about trade policy ahead of Trump’s inaugural address. Later, news that the Trump administration would likely apply 25% tariffs on imports from Canada and Mexico starting in February overshadowed the optimism. So, tariffs are still on the horizon, though not once Trump announced.
Limited expectations for the yen’s rise after Trump’s comments
We initially saw a significant rise in the prices of the Canadian dollar, Mexican peso and euro yesterday, as Trump did not set a timetable when he addressed tariffs. In fact, he has referred to himself as a “peacemaker and unifier,” suggesting that he may avoid actions that could cause significant tensions with other countries through comprehensive tariffs. However, one should not mistake this as a relaxation, as he later said that his government would impose 25% tariffs on imports on both sides of its borders.
The USD/JPY decline reached the slight horizontal support at 155.00 overnight. However, if prices resume the decline and we fall below this level, you will have a short-term uptrend established since September, around 144.00, to watch, followed by the 200-day moving average around the 152.80 area.
For traders expecting the USD/JPY to rise, they would now like to see prices break the key short-term resistance at 156.00-156.75. A crucial breakout here would signal bullish sentiment, which could open the door for subsequent technical purchases towards 160.00. But that’s not the basic scenario for me.
Trump intends to reform the trading system in order to “impose tariffs and taxes on foreign countries to enrich our citizens” by creating the Foreign Revenue Service. Clearly, his goals for reforming international trade policies prioritize U.S. industries and aim to reduce the trade deficit. Through the imposition of import tariffs, revenues will be redirected towards domestic economic growth and infrastructure development.
With the US dollar still largely supporting against other currencies, USD/JPY may not be the best pair against the yen for those looking to strengthen the Japanese currency. However, due to the narrowing yield spreads, I think USD/JPY’s upside is somewhat limited from here.
Japan’s interest hike supports the yen and weighs on the euro
The EUR/JPY pair fell to nearly 161.10 during the early European session on Tuesday. The Japanese yen also strengthened against the US dollar due to growing speculation that the Bank of Japan will raise interest rates at Friday’s monetary policy meeting. Later on Tuesday, Germany will release its ZEW survey for January.
The Bank of Japan is expected to raise interest rates at its next monetary policy meeting, and markets predict a 92% chance of the move by the end of the meeting on January 23-24. This would raise short-term borrowing costs to levels not seen since the 2008 global financial crisis.
On Tuesday, Japan’s deputy finance minister for international affairs and senior foreign exchange official, Atsushi Mimura, said the outlook for the U.S. economy depends on Trump’s macroeconomic policies. Meanwhile, Japanese Finance Minister Katsunobu Kato stated that officials will closely monitor the impact of US policies on Japan and the global economy, adding that he expects the Bank of Japan to implement appropriate monetary policies to achieve the 2% inflation target.
On the other hand, the ECB’s dovish outlook could send the euro lower against the Japanese yen. Policymakers at the ECB’s monetary policy meeting in December agreed to approach interest rate cuts cautiously and gradually. They also noted that weaker price pressures will likely lead to further rate cuts.
Traders expect the ECB to offer a 25 basis point rate cut at each of the ECB’s next four policy meetings, driven by concerns about the Eurozone’s economic outlook and the belief that inflationary pressures will remain weak.
