Head of FX Strategy
Summary: The Japanese yen is poised for event-driven volatility next week as both the Bank of Japan (BOJ) and FOMC meetings are scheduled. While signals on a BOJ pivot have become clearer lately, the resulting yen strength could remain uncertain. The BOJ needs to adopt a more hawkish stance both in action and rhetoric for the yen to strengthen, which remains unlikely. Additionally, a surprise hawkish turn from the FOMC poses a significant risk.
Next week marks a significant confrontation between the two leading central banks, with considerable implications for the Japanese yen. The Bank of Japan (BOJ) meets early in the week with announcement due on March 19 and the FOMC meeting announcement is due on March 20 (2am SGT on March 21).
This week marked a second consecutive month of hot CPI print in the US. Markets had just come to terms with the hot January inflation print and pushed back on its rate cut expectations, which were earlier expected to begin in March. Still, there was a sense of lingering relief with disinflation, as January was seen to be a one-off blip and possibly affected by seasonality. However, two months of inflation beat can no longer be called a blip. Today’s PPI number will tell us more on where the Fed’s preferred inflation metric, PCE, could land in February. Should the PPI data also indicate elevated inflation levels, it could trigger a serious reassessment of the Fed’s and the market’s expectations regarding disinflation.
The March FOMC meeting is unlikely to bring any changes to interest rates. The target range for the Fed Funds rate will likely remain unchanged at 5.25-5.50%. Money markets are indicating no probability of any rate adjustment during this meeting. Markets are also pretty much aligned to Fed’s easing expectations for 2024, pricing in just slightly over 75bps of rate cuts this year. This means any shifts in dot plot median can be unnerving for the markets.
The US economic growth has remained resilient so far, so it is unlikely that we get any adjustment to the GDP growth forecasts. However, upside risks to inflation forecasts are seen, and will likely amplify if PPI today also comes in hot. Market may start to reconsider whether the Fed’s March dot plot could see a hawkish shift, with the median dot indicating only 50bps of rate cuts this year as against December’s 75bps. As can be noted in the dot plot above, it will take only two Fed members to revise their expectation of 2024 policy rate higher by 25bps to move the median. Powell’s comments will also be key to watch for any shift in tone about any bumps in the confidence to achieving 2% inflation. Overall, risks for the FOMC meeting outcome next week are tilted hawkish.
The other key central bank to watch next week is the Bank of Japan, and markets have increasingly priced in an exit from negative rates there. Early results of wage negotiations, recent media reports from Jiji Press and Nikkei, as well as BOJ commentary have all signalled that the BOJ might be preparing for a lift-off. Timing still remains uncertain, though.
Some of Japan’s biggest employers have started to announce the results of this year’s union wage negotiations. Toyota agreed to meet its union’s pay demands in full with record raises. Honda agreed for wage hike of 5.6% while Nippon Steel agreed for 14.2%. Overall wage hike in 2023 was 3.58% and for 2024 forecast is over 4%, the highest in three decades.
While this maybe a clear green light for the BOJ, the market only prices in a 10bps rate hike next week with just over a 50% probability and USDJPY reaction has been muted. This is a reminder, that the fate of the still remains in the hands of the Fed rather than the BOJ itself.
If the BOJ exits negative interest rate policy next week, to bring the short-term interest rate to 0%, we could see the JPY going higher. The extreme short positioning and undervaluation of the yen are reasons enough to support a rally. However, if the BOJ was to pivot, it will likely come with a dovish narrative around not to expect a continuous increase in interest rates. This could cap gains, especially at a time when markets will be nervous about what to expect from the FOMC the next day.
On the other hand, an unchanged rate decision from the BOJ will come against modest expectations of a rate hike, and it will likely result in yen weakness even if the commentary supports the case for an April rate hike.
Going into next week, JPY faces risks from the clash of BOJ and FOMC. We outline four scenarios and the expected outcome for USDJPY in the table below.
In summary, risk reward remains tilted towards a weaker yen in light of the event risks next week. The real game changer for the JPY only happens if the BOJ removes negative interest rates and still guides for more interest rate hikes. That could trigger a USDJPY move below 140, but recent commentary suggests that remains unlikely. For now, that would mean USDJPY will retain its dependency on yield differentials, and it will remain a preferred carry play.
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