The narrowing expectations of interest rate differentials between the US and Japan have cooled down, prompting traders to reduce their bets on the yen rising.
23/12/2024
GMT Eight
After the policy meetings of the Federal Reserve and the Bank of Japan raised doubts about the speed of narrowing the US-Japan interest rate differential, traders are now cutting back on bets on the yen's rise. Prior to last week's meetings, strategists were betting that 2025 would be a strong year for the yen. But the market is now less optimistic about the yen's outlook, as Bank of Japan Governor Haruhiko Kuroda suggested that they may wait longer before raising interest rates again, while the Federal Reserve hinted that they will slow down monetary easing next year.
Option indicators show that after the meetings, traders' bullishness on the yen dropped to the lowest in a month. The latest data from the US Commodity Futures Trading Commission (CFTC) as of the week ending December 17 show that leveraged funds have increased their net short positions in the yen to about 44,926 contracts, the highest level since July.
Strategists at Mizuho Securities and Sumitomo Mitsui Insurance have recently downgraded their forecasts for the USD/JPY exchange rate. Mizuho raised its forecast for the USD/JPY exchange rate by the end of 2025 from 130 to around 145, while Sumitomo Mitsui Insurance currently expects 140, up from their initial forecast of 130.
Tsukasa Sugiura, market strategist at Sumitomo Mitsui Insurance, said: "Due to the extreme hawkishness of the Federal Reserve and the extreme dovishness of the Bank of Japan, we have changed our outlook. It now appears unlikely that the Bank of Japan will raise interest rates in January."
Last Friday, Bank of Japan Governor Haruhiko Kuroda said at a press conference on Thursday's decision that he needs more information on Japanese wages and Trump's policies, causing the yen exchange rate to fall to 157.93 yen per dollar, the lowest level since July. Foreign exchange strategists point out that if the Bank of Japan maintains interest rates unchanged until March or later next year, there is a risk that the yen will further weaken. Some say that a widening interest rate differential may also bring back yen carry trades - investors borrowing funds in Japan and then deploying them into higher-yielding markets, a popular strategy that sparked global market turmoil earlier this year.
Charu Chanana, Chief Investment Strategist at Sheng Bao Bank, said: "The hawkish stance of the Federal Reserve and the pause of the Bank of Japan may give yen traders new reasons to 'continue' action. The Federal Reserve and the Bank of Japan are both narrowing the yield differential, which has been pushed back to after the first quarter, so yen appreciation may also be pushed back to the second half of the year."
Mizuho's previous forecast for the yen was that due to narrowing policy interest rate differentials between the US and Japan and narrowing yield differentials on 10-year government bonds, the yen exchange rate would reach its highest level since early 2023. But upon seeing the Federal Reserve's latest monetary policy expectations, Mizuho immediately changed its forecast for the USD/JPY. The latest monetary policy expectations of the Federal Reserve suggest that they will only cut rates twice by 25 basis points next year.
Mizuho strategists Masafumi Yamamoto and Masayoshi Mihara wrote in a report: "Currently, in the context of the relatively strong US economy and high interest rate levels, the dollar may remain strong, so we have raised our forecast for the dollar."
Strategists warn that in the short term, the USD/JPY exchange rate could reach 160, a level that would increase the risk of intervention by the Bank of Japan and could even lead to an early rate hike by the Bank of Japan. Japanese Finance Minister Katsunobu Kato and Director of the Foreign Exchange Bureau Atsushi Mimura both warned last Friday that they would take appropriate measures to prevent excessive exchange rate fluctuations.
Nomura Securities analysts Kyohei Morita and Yujiro Goto wrote in a report: "We believe the Bank of Japan is more likely to wait until March to raise rates. In the short term, there is a high risk of yen depreciation overshooting, but we are watching for any verbal intervention and the possibility of the Bank of Japan shifting to a hawkish stance." They revised their earlier forecast of a rate hike in January.