The USD/JPY currency pair, which had been steadily rising since January 2024, recently broke its trendline, retreating from a peak of 161. Several factors have contributed to this shift in momentum, reflecting the complex interplay of economic data, central bank policies and market sentiment.
At the start of 2024, the USD/JPY began its ascent, driven by a combination of robust US economic data and a dovish stance from the Bank of Japan (BOJ). Strong US economic indicators, such as GDP growth and employment figures, bolstered the US dollar while the BOJ’s ultra-loose monetary policy, aimed at combating decades of deflation and weak economic growth kept the Japanese yen weak. This divergence in policy between US and Japan supported the upward trajectory of the USD/JPY.
The recent decline in the USD/JPY exchange rate can be largely due to the unwinding of carry trades.
In a carry trade between the US and Japan, investors capitalise on the historically low borrowing costs in Japan to invest in higher-yielding US dollar-denominated assets. This strategy can generate substantial returns as long as the interest rate differential remains significant and exchange rate fluctuations are minimal. The larger the interest rate difference, the more attractive the carry trade becomes, driving demand for the USD and strengthens the USD/JPY exchange rate.
The future trajectory of the USD/JPY will depend on several factors, the key one being the BOJ’s monetary policy decisions, especially given the rising wage growth and inflationary pressures in Japan. If the BOJ signals more tightening, JPY could strengthen further. On the other hand, US economic data and actions by the US Federal Reserve will continue to play a crucial role. Should the Fed adopt a more dovish stance, the USD might face additional downward pressure.
Moreover, geopolitical developments and global economic conditions will also influence market sentiment and currency movements. Investors should remain vigilant and consider these variables when making trading decisions.
In summary, the recent retreat of the USD/JPY from its peak of 161 marks a significant shift in the currency pair’s trend. Influenced by Japanese wage growth, a recent BOJ interest rate hike, potential government intervention, and evolving US economic indicators, the dynamics of the USD/JPY are becoming increasingly complex. As markets navigate these developments, the interplay between central bank policies and economic data will remain pivotal in shaping the future direction of the USD/JPY.
The writer is forex dealer at Phillip Nova
