EBC Markets Briefing | Yen is cracking under US election pressure

The yen dropped to its weakest level against the dollar in almost three months due to a strong dollar, spurred by Trump gaining ground in key battleground states and signs of a robust US labour market.

Japan’s top currency official’s warning last week after the yen weakened beyond the level underscored the possibility of further slippages despite intervention risks.

Tokyo stepped into the forex market around May to stem the yen’s declines, according to Ministry of Finance data. But the controversial move, combined with two rate hikes, has not halted the long-term trend.

“We expect the dollar-yen to readjust toward the end of the year, but in the near-term it looks like it will remain high at around 150,” wrote Yujiro Goto, head of forex strategy at Nomura Securities, in a note.

The yen is on track to be the worst performer among G7 currencies for a fourth consecutive year. US-Japan interest rate differentials, the largest driver of the pair, have only begun to narrow in 2024.

PM Shigeru Ishiba suggested earlier this month that the nation is not ready for more interest rate hikes, though he later said he would not intervene in monetary policy affairs.

“If we break 152, I see 156 if we do not see any intervention from the Ministry of Finance,” said Shoki Omori, chief desk strategist at Mizuho Securities. He added Japan can do little ahead of US election.

Wage-push

The IMF is gaining confidence over the sustainability of Japan’s inflation, and expects the BOJ to stay on a gradual path of raising interest rates in coming years, said mission chief Nada Choueiri.

“We have seen indicators of consumption starting to increase, and we have seen employees’ scheduled earnings starting to increase, and this is an indication of a positive price-wage cycle working in the economy.”

The fund expects Japan to reach a nominal neutral rate at about 1.5% - higher than private economists’ estimate of 1% - around the end of 2026. The central bank will unlikely act at this month’s meeting.

Japan's core inflation slowed in September due to the rollout of energy subsidies but an index excluding the effect of fuel held steady, a sign that broadening price pressure will prompt interest rate increases further.

The reading has exceeded the 2% target for well over two years. Governor Kazuo Ueda has said the bank will keep tightening if inflation remains on track to stably hit 2% as it projects.

Economy expanded an annualised 2.9% in Q2 as steady wage hikes underpinned consumer spending, though soft demand in China and slowing US growth cloud the outlook for the recovery.

Another key factor would be next year's wage negotiations. While many firms are likely to keep hiking pay, some may not repeat the increases offered this year if slowing demand weigh on profits, analysts say.

A different election

Speculative currency traders who vacillated all year on the dollar just made their biggest move in three years. They reduced dollar shorts by around $8 million in the second week of October.

Another sign of bullishness is the price of calls relative to puts on a broad dollar basket through the next 30 days has surged over the last month and is now at its highest mark since July.

US economic activity was little changed from September through early October and firms saw a slight uptick in hiring, the "Beige Book" showed. The soft landing has pushed Treasury yields higher.

Interest swaps show traders are expecting the Fed to lower rates by 128 bps through September 2025, compared with 195 bps priced in about a month ago.

This time, rising yields also reflect growing concern that the Republican Party could take control of both the White House and Congress after election, potentially boosting the federal deficit and inflation.

If 2020 when a similar tight race happened is the guide, the yen should have strengthened gradually heading into the election. However, there are few signs of upside momentum this month.

The reasons of yen appreciation four years ago included the Covid-19 pandemic plaguing the US and trade war de-escalation. Obviously we are at the other end of the tunnel.

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