Japan holds an enormous $1.17 trillion in foreign exchange reserves. However, deploying those reserves for currency market intervention could create significant unintended consequences. In particular, it could trigger a sharp rise in US Treasury yields, a scenario Washington would likely find unacceptable. Let's take a closer look at the situation and develop a trading plan for the USD/JPY pair.
The article covers the following subjects:
Major Takeaways
- Japan is unlikely to use Treasuries.
- The extra budget is putting pressure on the yen.
- Rising yields could trigger capital repatriation.
- Long positions on the USD/JPY pair can be considered on pullbacks.
Weekly Fundamental Forecast for Yen
Scott Bessent confirmed that 10-year Treasury yields are a priority for the US Treasury Department. His statement definitely encouraged USD/JPY bulls. Although Goldman Sachs estimates that Japan could conduct interventions similar to those in the spring another thirty times, its actual capacity is rather limited. Indeed, while total foreign exchange reserves stand at $1.17 trillion, a significant share of this amount consists of Treasuries.
Meanwhile, bulls have been driving USD/JPY quotes higher for 8 of the last 9 trading days, despite Japan's strong economy and the BoJ's readiness to tighten monetary policy. Real GDP in the first quarter grew by 0.5% QoQ and 2.1% YoY, exceeding expectations. The probability of an overnight rate hike in June stands at 77%.
Japan Real GDP
Source: Bloomberg.
Yen bulls were unsettled by Sanae Takaichi's decision to use a supplementary budget to cover expenses related to the conflict in the Middle East. Although the prime minister emphasized that the move should not be viewed as fiscal stimulus, such measures are likely to fuel inflation and increase bond issuance.
As a result, Japanese government bonds have faced a sell-off, pushing yields higher. Yields on 30-year bonds have climbed to record highs, while 10-year yields have reached their highest level since 1996.
Japanese Bond Yield
Source: Wall Street Journal.
Essentially, this is a clear contradiction between stimulative fiscal policy and restrictive monetary policy, which typically has a negative impact on the currency. In the fall of 2022, a similar situation led to the pound falling to historic lows and the resignation of Liz Truss's government.
The key question is: what yield will satisfy Japanese investors who have parked their money abroad? If residents begin repatriating capital to their home country, the USD/JPY pair will decline even without currency interventions. Another issue is that this process will lead to debt sell-offs in other markets, including the US market. Washington is concerned that the Japanese government may sell its Treasury holdings. However, speculators could do so instead of the authorities.
As USD/JPY quotes approach the psychologically important 160 level, the Japanese authorities are likely to intensify verbal intervention efforts. However, concerns over funding large-scale currency intervention, the inconsistency between fiscal and monetary policy, the favorable backdrop for the US dollar, and the absence of upcoming low-liquidity holiday periods suggest that speculators have nothing to worry about.
Weekly USDJPY Trading Plan
Against this backdrop, the probability of a renewed uptrend in the USD/JPY pair is increasing. Long positions initiated at 156.5 or above can be maintained, with additional buying opportunities considered during pullbacks.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of USDJPY in real time mode
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