USD/JPY forecast: Japan’s weak yen headache risks becoming a full-blown migraine

• USD/JPY has surged towards multi-decade highs following the Bank of Japan’s interest rate decision last week
• Japanese policymakers say the move has been driven by speculative forces rather than fundamentals, keeping the risk of BOJ intervention on the table
• There are merits to the claims if only looking at interest rate differentials
• USD/JPY sits in a textbook ascending triangle on the weekly chart, a bullish technical pattern if the price breaks higher

The summary

Japanese officials are  attempting to talk down the high-flying USD/JPY again, arguing moves over recent weeks do not reflect fundamentals but speculative activity. While there’s some merit to the claims, carry trades continue to promote yen weakness, keeping it levitating near multi-decade highs.

Sitting in a technical pattern that points the risk of substantial upside ahead, the weak yen headache facing  policymakers may soon turn into a full-blown migraine.

The background

USD/JPY is threatening to break to fresh 33-year highs, surging after the Bank of Japan’s interest rate decision last week. While it delivered its first interest rate increase in 17 years, ditching negative interest rates in the process, it was only 10 basis points, well telegraphed to markets, with no commitment to follow it up with another. Importantly, it said it had no immediate plans to scale back its massive quantitative easing program, continuing to buy Japanese government bonds at a rapid clip.

The announcements reinforced that Japan is extremely unlikely to embark on an aggressive monetary tightening program like other developed central banks earlier in the economic cycle, keeping the chasm in interest rate differentials between Japan and the rest of the world extremely wide. For a currency pair that’s largely driven by interest rate differentials, that’s important when considering the USD/JPY outlook.

With USD/JPY flirting with new highs, Japanese officials have wasted little time in trying to talk it down with Masato Kanda, Japan’s top currency diplomat, warning moves since the BOJ meeting were not driven by fundamentals but speculative forces, adding he wouldn't rule out any measures to combat them should they continue. That’s code for asking the BOJ to intervene on the government’s behalf, a tried and tested threat that’s delivered results in the past.

I can sympathise with Kanda given rate differentials between the US and Japan have compressed from when USD/JPY was last around these levels. You can see that in the chart below.

With a daily correlation with US 10-year yields of 0.84 since the start of 2024, it suggests that while rate differentials are still influencing directional movements, the magnitude of the moves are nowhere near as strong as what’s been seen previously. With JPY carry trades set to continue until we see sustained weakness in risker asset classes outside Japan, it points to continued pressure on the yen until that point.

And one glance at the technical setup for USD/JPY warns the headache for Japanese officials may soon turn to a migraine.

USD/JPY is in a textbook ascending triangle pattern, with a long-running uptrend from early 2022 intersecting with horizontal resistance just below 152.00. Given the distance between the two points when the triangle formed, convention suggests that if we do see an upside break, it could be substantial.

The trade setup

Just because USD/JPY sits in an established ascending triangle pattern does not mean a topside break is guaranteed. It is essential to wait for a breakout to improve confidence of the next price movement, so this is a trade idea to store away until that happens.

Should resistance around 151.95 give way, convention suggests the break may extend to as high as 180 should it play out in its entirety. While it has traded at those levels in the past, such a move comes across as unlikely in the absence of an unforeseen bearish event involving Japan.

However, 155 does not look out of reach, especially considering a break may encourage a fresh wave of bullish bets. 160 is another level USD/JPY did plenty of work around in the early 1990s, so at a stretch that could be another target.

The key thing to remember is to place a stop loss order below 151.95 if you buy the break, providing protection against a sudden reversal. Should the trade work in your favour, you could move it to your entry point, providing somewhat of a free hit on upside.  

The wildcard

There’s no guarantee USD/JPY will break higher. The carry trade could easily be disrupted, especially if major central banks are forced to cut interest rates aggressively on an abrupt slowdown for the global economy. Under such a scenario, USD/JPY could break its uptrend and aggressively unwind as capital is repatriated. A hard landing would be highly unlikely to promote USD/JPY upside.

The other wildcard would be if the Fed is forced to abandon rate cuts this year, a scenario that would likely see yield differentials with Japan balloon again. While that may pressure some riskier asset classes, it also would imply US growth and inflation have accelerated again, a combination that may promote even larger upside gains for USD/JPY.

-- Written by David Scutt

Follow David on Twitter @scutty