US dollar set for pullback against the yen

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The US dollar has retreated recently against the yen, down from a peak of above 144 at the start of the month to 140.6 at the time of writing. Even after this pullback, however, the US dollar has still gained close to 10% versus the yen since the start of the year. The dollar’s 2023 rally largely reflects the divergence between a hawkish Federal Reserve and a dovish Bank of Japan (BoJ).

But we believe the latest bout of dollar weakness is a sign of things to come, and we see the USDJPY pairing falling to around 124 by next June.

Japan’s finance ministry has shown a strong discomfort with USDJPY approaching the 145 level. This was the level at which the Japanese authorities intervened to support the yen in September last year, with officials stressing that the yen weakness was excessive and one-sided. While it took a further bout of yen buying at 150 in October, this did succeed in bolstering the yen.

The yen's rally last year illustrates that corrections can be rapid. USDJPY fell by as much as 16% in less than three months, from around 152 in late October 2022 to around 127 in mid-January 2023. Two key catalysts for the rapid fall were a significant easing in US core CPI data on 10 November (from 0.6% m/m to 0.3% m/m) and an unexpected adjustment in the BoJ's yield-curve control policy on 20 December. These events prompted a rapid liquidation of elevated net short yen positions, which resulted in a large rebound for the currency.

The same set of conditions that caused the yen to appreciate in late 2022 are in place again, in our view. Even though we cannot rule out near-term spikes in the pairing above 145 so long as the Fed remains hawkish and the BoJ stays dovish, we believe any further dollar strength would be short-lived. As in late 2022, we expect a moderation in US economic data and an adjustment in the BoJ's yield-curve control policy. We also see stretched net short yen positioning in the market—which could accelerate any move higher in the Japanese currency.

So, we believe investors should be cautious about chasing any spikes in the dollar-yen from here, and we advise US-dollar-based investors to retain any long-yen positions. This fits with our broader expectation for a period of US dollar weakness, as interest rate differentials between the US dollar and other currencies narrow. We therefore recommend investors with the Japanese yen, euro, British pound, or Swiss franc as their home currency to strengthen their home bias. We also expect gold to be a beneificary, with a potential rally to USD 2,250/oz by June of next year.