Behind the USD/JPY rollercoaster: analysing central bank moves and macro-economic contrasts

The last 24 hours have been extremely volatile for USD/JPY. The price reached as high as 160.22, only to fall back to levels seen roughly 13 days earlier, on Tuesday, April 16.
 

No official comment has suggested that the Bank of Japan (BOJ) intervened in the dollar-Japanese yen exchange rate. However, the dramatic drop from 160.23 to 154.49 bears all the hallmarks of central bank intervention. Additionally, Japanese government and central bank members have been warning for weeks about the yen's weakness.
 

While the drop in the JPY makes Japanese exports more attractive to foreign buyers, it also spurs inflation in the economy, which is deeply dependent on import of fossil fuels.
 

Why is the Japanese Yen so weak?
 

Interest rates in Japan are at just 0.10%, while they are at 5.5% in the United States, making it very attractive for investors to borrow in the Japanese yen and invest directly in U.S. treasuries to capitalize on the yield differential.
 

Retail traders can also, via FX and CFD brokers like ThinkMarkets, amplify the yield differential by trading with leverage. With just two times leverage, the “carry trade” becomes 5.1 x 2 = 10.2% annual, or with 5 times leverage, 25.5%, before fees. But as we saw overnight, the carry trade comes with risks.
 

If we delve deeper into the economic conditions of two contrasting nations, we find that Japan's GDP grew by 1.2% in the fourth quarter of 2023, while the U.S. saw a more significant increase of 3.1% over the same period. The inflation rate is also higher in the U.S. at 3.5%, compared to 2.7% in Japan.
 

Japan faces long-term structural issues related to its ageing population, a challenge not currently faced by the U.S. Additionally, inflation has remained persistently high in the U.S., making it difficult for the Federal Reserve to reduce interest rates, with the possibility of the first-rate cut occurring in November 2024. This trend of fewer-than-expected rate cuts is a global phenomenon, further increasing the likelihood of renewed pressure on the yen, given the interest rate differentials between countries and their relative economic growth, as the GDP figures exemplify.
 

Historically, while there have been significant interventions in the Japanese yen, it is rare for a single intervention to reverse the USD/JPY exchange rate trend. Typically, multiple interventions are required, often involving a coordinated effort.
 

What is next for USD/JPY?
 

Market tension is expected to rise in the coming days, especially with the Federal Reserve's rate meeting on Wednesday, which could spur further dollar buying and potentially push the USD/JPY higher. From a technical perspective, the price recently dipped to around 154.49, but the longer-term trend remains bullish as long as it remains above 154.40. The USD/JPY has already seen a slight rebound, with the next resistance levels at 157.04, 158.47, and 159.50.
 

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