USD/JPY - Short Term Peak In Place?

USD/JPY may struggle to make fresh highs if we see a more rangebound US Tsy environment and plateauing of Fed hike expectations.

• JPY has outperformed within the G10 FX space today. While USD/JPY has yet to breach the overnight low around 129.50, it has significantly outperformed the likes of AUD and NZD.
• Lower US yields are certainly aiding the yen move. Correlations between yields and G10 FX continue to show the yen as the most sensitive in the bloc to such moves.
• The first chart below plots market pricing for the Fed funds rate in Feb 2023 against USD/JPY. Such expectations have started to plateau in recent weeks.
• A combination of factors are at play - a 75bps hike has been taken off the table in the near term. Doubts are also rising around how high the terminal Fed fund rates can rise, particularly in an environment where global growth expectations are being revised down and recession risks are rising.

Fig 1: USD/JPY & Fed Rate Expectations

Source: MNI/Bloomberg

• A flatlining of Fed expectations/more range bound environment for UST yields takes away one source of upside impetus for USD/JPY.
• This may see yen more driven by broader risk sentiment in the near term. Weaker equities and/or higher VIX levels have typically provided a positive yen backdrop.
• This is not withstanding the negative terms of trade backdrop for Japan, which has weighed on the trade position and the JPY.
• Importantly though, JPY is screening cheap on longer term valuation metrics, so arguably a degree of this is already priced in. The second chart below shows the JPY REER is at record lows and is 20% below its 10-year moving average.

Fig 2: JPY Cheap On Longer Term Metrics

Source: MNI/Bloomberg