Market Recap
The Japanese yen suffered further losses against the U.S. dollar in the third quarter, undermined by divergent monetary policies from the Bank of Japan and the Federal Reserve. On the one hand, the FOMC continued to raise borrowing costs as part of its aggressive strategy to restore price stability, driving its benchmark rate to the highest level since 2002 and pushing U.S. Treasury yields to multi-year highs across most maturities.
In contrast, the BoJ maintained an ultra-dovish stance for fear that a premature shift in strategy could jeopardize the effort to eradicate the country's deflationary mindset. Although the BoJ, under the leadership of Kazuo Ueda, introduced slight adjustments to the yield curve in August, there was little indication that the monetary authority was ready to discontinue negative interest rates any time soon, even if headline CPI had remained above the 2.0% target for more than a year.
Against this backdrop, USD/JPY staged a strong rally, breaking above the psychological 148.00 level and reaching its highest mark in almost a year in late September, a clear sign that the bulls remain firmly in control of the market for now.
Market dynamics are not likely to change substantially heading into the fourth quarter, meaning the yen may find itself inclined towards further depreciation initially, albeit with some moderation, as on-and-off talk of FX intervention by the Japanese government may deter speculators from precipitating excessive weakness.
This article is specifically dedicated to analyzing the fundamental factors that could drive the yen in the coming months. If you are interested in a detailed exploration of the technical outlook and price action dynamics, don't miss the opportunity to download the full Q4 yen trading guide. It's available for free!
US Government Yields Versus Japanese Government Yields
Source: TradingView, Prepared by Diego Colman
Key Fundamental Drivers for the Yen
Exploring in detail, there are two potential factors that may lend support to the U.S. currency in detriment of the yen in the near term: firstly, the guidance from the Fed suggesting the possibility of another quarter-point hike this year, and secondly, the resolute commitment of U.S. policymakers to maintaining interest rates higher for longer.
Towards the latter part of the fourth quarter, the tide, however, may turn in favor of the yen, as the Bank of Japan initiates preparations for a departure from its exceptionally accommodative policy. In this context, Governor Ueda has hinted that enough consumer price data might be at hand by year-end to contemplate potential adjustments to borrowing costs.
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| Change in | Longs | Shorts | OI |
| Daily | -2% | 4% | 2% |
| Weekly | -4% | -8% | -6% |
BoJ’s Policy Shift on the Horizon?
Taken together, the emerging discourse indicates a growing inclination among policymakers to consider moving away from negative interest rates amid excessive yen devaluation and rising inflation. The message may also be part of a proactive strategy to provide investors with sufficient lead time and early communication to absorb these developments, with the goal of preventing market disruptions and mitigating unexpected shocks as the policy shift unfolds.
Because markets are forward-looking, investors may consider taking preemptive steps in anticipation of the Bank of Japan's normalization cycle, projected to commence in the spring of 2024. As traders attempt to front-run this shift, USD/JPY may come under pressure towards the end of the year. Therefore, it's conceivable that the fourth quarter will start off with yen weakness, followed by a period of strength relative to the U.S. dollar.
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