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Summary
- USD/JPY is trading very near the middle of the range seen since the Japanese Ministry of Finance (MoF) intervened in the FX market in late April.
- Over this period, the US 2-year yield is currently near the bottom of the prevailing ~4.7%/~5.0 range.
- Tomorrow’s US non-farm payrolls (NFP) report will be key for determining price action for USD/JPY and US yields, ahead of next week’s Bank of Japan (BoJ) and Federal Reserve (Fed) policy updates.
Market Implications
- We like to sell rallies in USD/JPY ahead of this event risk, given the threat of further intervention and a potentially hawkish BoJ turn.
- The US 2-year yield remains a buy-on-price dips, with a possible break below 4.7% opening considerable additional downside for short-end yields.
US Short-End Yields Near Bottom of Range
When the US 2-year yield was trading near 5% in early April, we flagged our bias to buy into the rise, saying yields looked stretched to the upside.
Price action since then has proven our instinct correct. The US 2-year yield has not traded convincingly above 5% this year. Instead, it has traded lower as dip buyers (us included) see it as a compelling entry point for initiating long positioning.
Chart 1: US 2-Year Treasury Yield = Orange Line
In this period, the 2-year yield has twice traded down to ~4.7% and bounced.
Ahead of tomorrow’s NFP, the yield is currently trading at ~4.73%, near last month’s double bottom.
Clearly, much depends on the jobs data. Should the data come in stronger than expected, we will probably remain within the 4.7-5.0% range. In this scenario, we think the strategy of fading higher yields will remain in place.
Should the data come in close to expectations, we expect no material bounce in yields. There may be limited upward pressure.
The most interesting scenario would be weaker-than-expected data. Should this happen, we think yields will develop substantial downside momentum, and the 4.5% level, last seen in March, could come into play again.
Middle-of-the-Range USD/JPY Remains a Sell-on-Rallies
After printing above 160 in late April, USD/JPY has traded in a ~152/~160 range and is currently midrange.
Chart 2: USD/JPY Spot Rate = Orange Line
That move above 160 prompted MoF FX intervention.
Prior to the Japanese authorities buying JPY in the market, USD/JPY was a virtual one-way bet, trading about 15% higher from the ~140 level seen at the beginning of 2024.
This one-way bet was largely fuelled by the positive carry favouring the USD, a dynamic that intensified as US yields rose in the first few months of the year.
Yield differentials still favour the USD.
This is a compelling reason to buy USD/JPY and (in our view) is a key reason why the pair has not fallen further post-MoF intervention. However, we think the threat of further intervention and possibility of US short-end yields falling further mean USD/JPY remains a sell-on-rallies.
The BoJ and Fed Update Policy Next Week
Tomorrow’s NFP will almost certainly set the near-term direction for US yields and the dollar. This data is always hotly anticipated.
Beyond this immediate event risk, markets also face rate decisions from the Fed (on 12 June) and BoJ (on 14 June).
The market prices virtually zero probability of a Fed rate move next week.
Nonetheless, the market will focus on the central bank’s messaging.
My colleague Dominique Dwor-Frecaut expects the Fed to retain its easing bias but convey a shallower easing cycle, with the 2024 median dot to show only one cut and the long-term dot to increase.
Moreover, Dominique expects the presser to surprise on the hawkish side. She still expects no cuts in 2024 against market expectations of two cuts.
Therefore, the Fed meeting could surprise markets, especially given the sharp fall in yields over recent weeks.
Meanwhile, there is also a small probability of a BoJ rate move next week, with the market pricing an ~8% probability of a 10bps rise.
Speculation mounts about the BoJ next week discussing a reduction of bond purchases. This would represent another step towards policy normalisation, away from the negative interest rate policy and aggressive quantitative easing.
Any further step towards reducing accommodative monetary policy will probably be positive for the yen and should lead to additional downward pressure on USD/JPY.
Conclusion
The next week sees much event risk for markets. The NFP is first, followed by next week’s Fed and BoJ rate decisions. Our bias is for lower US yields and to fade strength in USD/JPY.