As the US dollar falls, the Japanese yen becomes “the hottest news in town.” That’s why.

This is the return currency.

The Japanese yen, one of the world’s worst-performing major currencies in 2022, surged on Friday to a seven-month high against the U.S. dollar, which is now reeling as traders bet that the Bank of Japan will finally join other major central banks in tightening monetary policy. policy.

Thursday’s December reading of U.S. inflation, which was in line with expectations, “allowed foreign exchange markets to return to the main event – a potential dramatic change in the policy of the Bank of Japan and possibly a significant decrease” in the dollar/yen currency pair. Chris Turner, global head of markets at Dutch bank ING, said in a Friday note.

“It’s the hottest story in town right now,” he said.

In addition, options traders are poised for a potential significant move in the yen following next week’s BOJ policy meeting, Turner said.

The US dollar fell 1.2% on Friday to 127.67 Japanese yen USDJPY.
-1.11%.
The dollar retreated about 16% after breaking above the 150 yen level in October for the first time since 1990.

The dollar, which rose sharply in 2022 as the Federal Reserve launched a dizzying streak of aggressive rate hikes in an attempt to curb inflation, has been retreating since the fall. US dollar index ICE DXY,
-0.06%,
the currency’s performance against a basket of six major competitors was down 10.8% from a 20-year high set in October. What’s more, the index has retraced half of its gains since bottoming out on January 6, 2021, Mark Chandler, chief market strategist at Bannockburn Global Forex, noted in a Friday note.

See: US dollar suffers first death cross since 2020 as rally collapses

“The Japanese yen led the way against the dollar, gaining 2.8% this week amid heightened speculation that the BOJ may take another step away from its loose monetary policy as early as next week’s meeting.” , he wrote.

The Bank of Japan shocked global financial markets in December when it effectively eased a long-standing yield cap on 10-year government bonds in a policy known as yield curve control. The surprise move was seen as potentially pointing the way for broader tightening by the last major global central bank to maintain ultra-loose monetary policy, although outgoing BOJ Governor Haruhiko Kuroda denied that this was a precursor to the tightening.

Global investors have been alarmed that the Bank of Japan may eventually abandon its role as the last remaining low-interest anchor among the world’s largest central banks.

Since then, the Bank of Japan has faced greater pressure to tighten policy. This decision in December allowed the yield on 10-year Japanese government bonds TMBMKJP-10Y,
0.511%
trading at 0.5%, compared to the previous 0.25% cap, emboldened traders to test the central bank.

Yields rose briefly to 0.545% in Asia on Friday. To stem the rally, the BOJ bought 1.8 trillion yen worth of JGBs with maturities ranging from 1 to 25 years after it bought 4.6 trillion yen worth of JGBs on Thursday, the largest daily bond purchases by the BOJ in the entire story, according to The Wall Street Journal.

While the prospect of a change in BOJ policy is the main driver of the yen’s rise, there are other bullish factors, Stephen Barrow, head of G-10 strategy at Standard Bank, said in a Friday note.

“The economic recovery in China should support sentiment in Asia and provide additional support to the yen,” he wrote.

The course of the war in Ukraine will also be a driving force, Barrow said. The absence of a further escalation of the conflict would have supported the yen after Japan’s terms of trade were hit hard last year by a sharp rise in energy prices following Russia’s invasion of Ukraine. The terms of trade is the ratio of a country’s export prices to its import prices.

“In our view, adverse terms of trade usually lead to currency weakness, and we have seen this not only for the yen, but also for other major energy importers such as the UK and the eurozone,” Barrow said. “If the recent drop in energy prices continues and these terms of trade change, the yen should rise.”

Opportunities for the yen to strengthen are probably greatest against the dollar, rather than against currencies that could improve terms of trade, such as the euro EURJPY.
-1.29%
and the British pound GBPJPY,
-0.93%,
the strategist said, noting that Standard Bank’s target for 2023 is 120 yen.

Strategists warned that the Bank of Japan may not have much to offer at its January meeting.

“Looking ahead next week, the January 18 BOJ meeting will draw attention, although it is likely to lead to inaction,” Keith Jaques, global macro strategist at Société Générale, said in a Friday note. “Details of the review of yield curve management changes may or may not be published.”

However, the dollar/yen “still attracts the most interest” in the currency options market, said ING’s Turner.

“Implied one-week volatility remains at a very high 20% and volatility at next Wednesday’s BOJ meeting is estimated at 40% or close to 1.7% in USD/JPY spot currency” or dollar/yen.

The dollar/yen’s 2% drop on Thursday showed that the currency options market may continue to underestimate volatility, he said.

“This huge interest in USD/JPY is understandable. The Bank of Japan may be on the cusp of the biggest policy change in decades. Even short-term JPY interest rate swaps have started moving and are at their highest level (around 30 basis points) since 2008!” Turner said.

Traders are unlikely to want to stand in the way of the dollar’s fall against the yen, he said, leaving 126.50 yen as a short-term target for the dollar against the yen.

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