USDJPY Recalibrating BoJ & Fed Policy Expectations

The yen's lacklustre performance has been evident at the commencement of the new calendar year, retracting the gains accrued over the holiday period. This retreat has propelled the USD/JPY pair above the 145.00-level on last Thursday, surpassing the low recorded on December 28th at 140.25. As of now, the pair is trading at its highest level since just before the Bank of Japan's (BoJ) last policy meeting on December 19th, during which they refrained from signalling an imminent rate hike.

From my perspective, recent pronouncements from the BoJ Governor have fortified the expectation that the BoJ is unlikely to abandon negative rates this month. The Governor expressed that the likelihood of such action "does not seem very high at this point," citing the need for more information ahead of the January policy meeting to gain confidence in sustained wage growth—a prerequisite for the BoJ to initiate rate hikes. Moreover, lingering speculation about a potential rate hike this month has been further subdued by the uncertainty stemming from the recent earthquake in Japan. While the negative economic impact is anticipated to be limited, the short-term uncertainty has raised the bar for the BoJ to exit negative rates at this juncture. It seems more probable that the BoJ will postpone rate hikes until at least March, and more likely April. This delayed departure from negative rates, even if by a couple of months, has triggered renewed selling of the yen at the beginning of this year.

Coinciding with the yen's weakening is a modest rebound in yields outside of Japan, following a sharp decline at the end of the previous year. The 10-year US Treasury yield has increased by just over 20 basis points since its late December low. In my analysis, market participants, initially pricing in earlier and more substantial rate cuts by major central banks in 2024, are now scaling back those expectations at the beginning of this year. This adjustment may reflect a cautious approach toward the possibility that rate cut expectations have already advanced significantly and would require additional confirmation of slowing inflation and growth in the upcoming months to prompt central banks into action.

Recent economic data has introduced some uncertainty about whether the Federal Reserve and other major central banks will cut rates as early as Q1. According to the ADP survey, there is an estimated increase of 164,000 in private employment growth for December, surpassing the average NFP private job gains of 130,000 per month in the six months leading up to the end of November. This contrasts with the signal from the JOLTs report for November, released earlier in the week, indicating a decline in the hiring rate to its lowest level since the COVID shock in early 2020. From my perspective, the Fed will seek additional evidence that labour demand continues to decelerate in last Friday’s NFP report, along with improvements in labour supply, to gain confidence in initiating rate cuts in response to slowing inflation. But as the NFP report came higher than expected it could result in an extend rebound of the US dollar at the beginning of this year.

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