Can the Japanese yen rely on its safe zone appeal in the second quarter – will the USD fight back?

Can the Japanese yen rely on its safe-haven appeal to gain dominance over the US dollar in the second quarter?

Recent inflationary pressures in Japan have revived hopes that newly elected Governor Ueda will move away from the current ultra-loose monetary policy. After ten years of loose monetary policy by the BoJ (Bank of Japan) under former governor Haruhiko Kuroda, pressure is mounting on the central bank to clarify its future monetary policy stance in order to manage expectations.

While the BoJ is expected to maintain the current status quo in the second quarter, the question remains how the Federal Reserve will respond to further turmoil in the banking sector.

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BOJ – Probability distribution for 2023

After announcing a series of aggressive rate hikes during 2022, the Federal Reserve continued to raise rates, pushing the final rate to 5%. This means that the Fed raised interest rates by 4.75 % in one year. While the higher rates were an important driver of USD strength, they also meant a significant increase in borrowing costs, making it harder to finance debt.

Shortly after the collapse of Silicon Valley Bank (SVB) and Signature Bank, concerns about the financial health of Credit Suisse and First Republic Bank heightened fears of contagion. To allay these fears, the Federal Reserve, the US Treasury and the FDIC confirmed that customers of the failed banks would have access to their deposits. Two days after the US authorities announced these emergency measures to restore confidence in the banking sector, Credit Suisse’s largest shareholder made it clear that it would not provide financial support to the troubled bank. Due to regulatory requirements, the Saudi National Bank cannot increase its stake in the bank above the 10% threshold.

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Fears of a possible banking crisis in the world’s largest economy (the United States) sent shivers through the markets. Moreover, the probability of a recession in the US by early next year rose to 60%.

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Source: Refinitiv DataStream

In response to the recent turmoil, Fed expectations have fallen sharply, boosting the yen as a safe haven. As US Treasury yields remain under pressure, a continuation of this theme could drive USD/JPY lower in the second quarter.

While forecasts currently expect the Fed to cut rates by 50 basis points before the end of the year, the BoJ (Bank of Japan) continues to maintain its ultra-loose monetary policy.

Although the interest rate differential has weighed heavily on the JPY, the reassessment of lower interest rate expectations and a stable banking system could cause the yen to appreciate against its dollar counterpart.

US probability distribution of interest rate hikes for the rest of 2023

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Source: Refinitiv

USD/JPY technical analysis

After three consecutive months of losses, USD/JPY fell to the midpoint of the 2021-2022 range before moving back up. In February, the Federal Reserve struck a more hawkish tone for the March 2023 FOMC meeting, pushing yields and the dollar higher. Although the bulls temporarily managed to push the major currency pair back above the 200-day MA (137.450), a shift in the fundamental backdrop and the US bank meltdown wiped out much of February’s gains.

With USD/JPY trading at a 10% discount over the past six months, both bulls and bears have some key technical levels to overcome before seeing a clear trend.

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How to trade USD/JPY

USD/JPY Weekly Chart

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Source: TradingView

On the daily chart below, the price is moving within the confines of a falling wedge. After a brief period of consolidation around the 50-day MA (132.500), an increase in bearish momentum has initiated a move towards support, currently at the important psychological 130.00 level.

In the next three months, the January low at 127.233 could provide additional support. If prices fall below the lower boundary of the falling wedge, the bears could maintain the downtrend. The next support target is at the 61.8% Fibonacci factor of the 2021-2022 move at 121.445 and could pave the way for a move towards 115.00.

USD/JPY Daily Chart

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