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  • Joseph Barreca

Peak delayed until Q4

Updated: Sep 6, 2022



The USD/JPY declined to the 130-level due to comments by Fed Chair Jerome Powell following the July FOMC meeting but turned higher again after remarks from several Fed officials changed the trajectory of market expectations. The dollar's strength gained momentum after Powell indicated that the Fed was determined to rein in inflation at his speech at Jackson Hole. The USD/JPY is now well within reach of 140. We expect the USD/JPY to peak later than we had forecast to date since the Fed is unlikely to change its stance anytime soon. Japanese authorities are likely to step up efforts to stop the yen from weakening if the USD/JPY passes 140, weighing on further upside.

The USD/JPY opened the month at 133.35. It fell steeply to 130.40 due to dollar selling and yen buying from the end of July, weakness in the ISM Manufacturing Index announced on 1 August, and House Speaker Nancy Pelosi's visit to Taiwan on 2 August. However, the dollar firmed after several Fed officials reined in expectations of a change in monetary policy. policy. The USD/JPY recovered to above 135 following the announcement of a strong ISM Non-Manufacturing Index on 3 August. The July CPI announced on 7 August was below the market's forecast, and the USD/JPY fell back to the 131 level but remained directionless for a time, partly due to the Obon holidays in Japan.

As market participants gradually returned to the fray, St. Louis Fed President James Bullard on 18 August said he favored a 75bp hike at the September FOMC, sparking a rise in UST yields which also worked to push the dollar higher. The USD/JPY rose to above 137 on 22 August. August. The market remained in wait-and-see mode ahead of Fed Chair Powell's speech at the Jackson Hole economic symposium on 26 August, but dollar strength gained momentum after the speech. The USD/JPY rose to touch 139 on 29 August as oil prices, which had been trending lower since June, came under upward pressure, Japan's expected inflation rate rose, and a decline in the real interest rate raised expectations of yen weakness.

The USD/JPY was top-heavy at this level but stayed above 138 as UST

yields remained elevated. As of the time of writing this report on 30 August, the

USD/JPY had risen to a high for the month of 139.08 (Figure 1)

These conditions resulted in the dollar strengthening across the board in August. The Norwegian krone and Australian dollar, which are resource nation currencies, performed relatively well due to the rally in oil prices (Figure 2).

At his post-FOMC meeting press conference in July, Fed Chair Powell suggested that the Fed would consider easing the pace of rate hikes as the federal funds rate was broadly in line with the neutral rate of interest. The market took this as a signal that the current rate hike cycle was in its final stages, and expectations for a rate cut early next year also emerged. Stock prices rose, and the dollar weakened from the second half of July as a result, even though the Fed continued to tighten monetary policy, including scaling back its balance sheet.

Meanwhile, the USD/JPY fell from a high of 139.39 on 14 July to a low of 130.40 on 2 August, declining by 9 yen in half a month due to yen buying in a flight to safety as House Speaker Pelosi's visit to Taiwan sparked fears of greater tensions in US-China relations over Taiwan


However, several Fed officials made a series of comments aimed at correcting the market's interpretation of Powell's press conference in July, which had triggered the sharp moves in the USD/JPY. This had the intended effect of halting the dollar's slide, with the dollar then gaining strength again ahead of Powell's speech at the Jackson Hole economic symposium on 26 August. The closely watched speech was short and to the point, shutting down market expectations that the Fed would change course (raise rates) anytime soon. soon. Powell said the Fed would raise the policy rate further and it would stay high for some time. This sent shock waves through the stock market, which had been rising in hopes of a shift to a looser policy, resulting in a decline in share prices.

In the forex market, the dollar's strength gained momentum. On top of that, BOJ Governor Haruhiko Kuroda's comment that Japan has little choice but to remain in easing mode stood in stark contrast to other central bankers at Jackson Hole who argued for the need to tighten policy to bring inflation under control. This served as a reminder of the divergence in monetary policy in Japan and overseas, with the yen weakening across the board the next day on 29 August and the USD/JPY rising to touch 139 for the first time since 15 July.

However, as we pointed out last month, the correction in the USD/JPY could be a transitory move that has repeated itself on and off over the last few months. The move was quite rapid and dramatic, but it was still a case of the market falling back after a rise, as expected. Based on movement since the second half of July, we think a change in the Fed's stance, including reducing the pace of rate hikes, will have to come into view before the USD/JPY really turns around.

On that point, we had expected dollar strength/yen weakness to peak in 3Q (Jul- Sep), but now expect the timing to be pushed back somewhat. The August jobs report and CPI will be announced in mid-September.

This data will be key for policymaking, but at least at the September FOMC, Powell is likely to take care that policy decisions do not spark expectations that the Fed will slow the pace of hikes as soon as the neutral rate is reached. In fact, comments by Fed officials around the time of the Jackson Hole symposium seemed to be aimed at getting the market to factor in another 75bp hike in September. This is consistent with Powell's concern that letting inflation remains high will push up inflation expectations and lower real interest rates, curbing the effects of monetary tightening and ultimately accelerating inflation (Figure 3). In addition, the outlook for the fed funds rate is likely to be raised again, as it was in June (Figure 4).

We see the possibility that the dollar could strengthen further as expectations for the September FOMC meeting develop based on upcoming employment and inflation data. The BOJ's monetary policy meeting and Governor Kuroda's press conference are scheduled immediately after the FOMC. Kuroda's recent remarks suggest that the BOJ is unlikely to take any action at the policy meeting. The pace of rate hikes also looks set to accelerate in Europe. The sense of divergence in monetary policy in Japan and overseas could resurface in this environment, putting downside pressure on the yen along with bond market trading on monetary policy normalization. The USD/JPY has already risen to 139 and looks set to finally reach the watershed 140 mark.

Dealing with inflation is currently the Fed's top priority, and both hawks and doves on the FOMC are reluctant to relax tightening measures. This kind of determination and consensus is not likely to change any time soon. New York Fed President John Williams on 30 August also dismissed speculation that the Fed will cut rates next year. At his post-meeting conference, Powell will likely reiterate his stance that policy will be data-driven and not make any commitments. We do not expect a repeat of the clumsy communication at the July meeting. We, therefore, do not expect the September FOMC to provide any hint of when the Fed's hawkishness will fade, meaning the dollar is likely to remain strong for some time.

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