USD/JPY Plummets as Japanese Investors Anticipate Fed Yield Curve Action
JPY has been a big winner in G10 FX markets so far this week, with USDJPY plummeting from highs of above 109.50 to its current levels of below 108.00.
The cross has now fully reversed last week’s gains, in which it rose from around 107.50 to just below 110.00.
What explains this sudden reversal in the Japanese Yen’s fortunes vs USD?
It's certainly not a USD story, as USD is pretty much flat on the week (with DXY just below 97.00).
The explanation appears to be to do with market participants trying to bet on the future of US/Japanese yield differentials.
NOTE: Yield differentials are a crucial driver of USDJPY - must of last week’s rise in the cross was driven by a sell off in US government bonds (so yields went higher), meaning compared to Japanese government bond yields, US bonds became comparatively more attractive, causing flows from Japan to the US (and strength in USDJPY).
On this week’s decline in USDJPY, Yukio Ishizuki, foreign exchange strategist at Daiwa Securities, says “Japanese names have been very active since Monday in USDJPY, trying to trade off the chance of some kind of yield-curve control from the Fed”.
Elsewhere, traders have this week noted how Japanese investors have been heavy sellers of dollars for yen this week, positioning for possibly lower US yields.
Confused? let me explain everything…
Tomorrow we have an FOMC meeting (stay tuned for my preview of the event!).
One policy that the FOMC has been considering in recent weeks is something called yield curve control - this is essentially where the Fed sets a target price for a US government bond in the secondary market (they will likely target the 3-year bond), below which prices are not allowed to move (because the Fed will essentially buy as much as is necessary to keep prices above this level). This ensures that the government can continue to borrow at a favourable interest rate (remember, when bond prices are high, interest rates/yields are low).
Following last week’s rise in US bond yields (or sell-off in the price), Japanese investors appear to have upped their bets that the Fed will adopt this programme.
If the Fed does do yield curve control, this will erode the US/Japan yield differential, which will result in flows from US bonds to Japanese bonds, resulting in USDJPY weakness - this is essentially what those Japanese investors appear to have been front running.
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