The USD/JPY pair remains robust and continues its upward trajectory despite a number of headwinds. So, what's keeping the American currency afloat, and what highs can it reach in the near future against its Japanese counterpart?
USD holds a strong trump card
In recent days, the main driver for the US dollar has been market panic. Traders have been closely monitoring the drama surrounding the US national debt and waiting for Republicans and Democrats to agree on raising its ceiling.
Reaching a compromise on this issue as quickly as possible is a strategic task for Congress leaders as the US funds could be depleted in early June and the country may stop paying its bills.
Last week, several authoritative analysts warned that a default of the world's largest economy could turn into a disaster not only for the United States but for the entire world.
Fear of a global recession has returned the demand for the safe-haven dollar, which has recently seemed rather weak due to the market's waning hawkish expectations of the Federal Reserve's further monetary policy.
Last week, the greenback's rate jumped against a basket of major currencies by 1.4% and could have shown spectacular growth yesterday if the US national debt issue had been resolved after US President Joe Biden's meeting with leading Republican in Congress, Kevin McCarthy.
Although yesterday's negotiations did not bring the long-awaited solution to the national debt problem, they significantly increased the likelihood of positive developments. Market participants were inspired by K. McCarthy's statement about the possible deal by the end of the week.
Such a scenario is negative for the greenback. That's why yesterday's USD growth was quite modest in all directions, including the pair with the yen (+0.2%).
Of course, the market's reaction to the news about the upcoming resolution of the US debt crisis could have been more intensive. Many analysts believe that the dollar had every chance to plummet on the wave of market optimism. However, yesterday, USD received quite powerful hawkish support.
On Tuesday, several Federal Reserve members lobbied for further rate increases, citing persistent inflation. Among them were Austan Goolsbee (FRB Chicago), Raphael Bostic (FRB Atlanta), Thomas Barkin (FRB Richmond), and Loretta Mester (FRB Cleveland).
The hawkish rhetoric of American officials prompted a sharp jump in the yield of the US Treasuries. As a result of yesterday's trading, the yield on 2-year bonds rose by 7 b.p. to 4.12%, and the 10-year Treasuries yields rose by 4 b.p. to 3.55%.
Against this backdrop, the USD/JPY pair reached a new weekly high above the 136.60 level, before slightly retracting. As we see, market participants continue to revise their forecasts concerning the Federal Reserve's future actions. They have noticeably reduced the likelihood of a pause in the tightening cycle in June and no longer expect a sharp drop in interest rates by year-end.
The prospect of a strong monetary divergence between the US and Japan, which signaled a continuation of dovish policy last week, could be a potent growth driver for the USD/JPY pair.
Most analysts expect a further rise in the major pair even if the conflict around the US debt ceiling is resolved by the end of the week and undermines the demand for the dollar as a safe-haven asset.
Why does JPY stand no chance?
The market's hawkish sentiment towards the Fed's future monetary policy is not the only factor putting pressure on the Japanese currency.
The main obstacle for the yen is the Bank of Japan's (BOJ) commitment to dovish policy, which seems to be maintained much longer than the market anticipated a few weeks ago when Kazuo Ueda took over as the new BOJ governor.
Despite Haruhiko Kuroda's successor announcing a review of the current policy in April, he made it clear that he would not initiate any changes until the economy recovers and inflation becomes stable.
Today's Q1 GDP report for Japan shows that the first condition is nearly met. According to the statistics, the world's third-largest economy grew by 1.6% annually from January to March, significantly outperforming economists' estimates of a 0.7% rise.
This is the first positive dynamic in Japan's GDP in three quarters. In the last quarter of the previous year, the country's economy shrank by 0.1%.
This positive shift suggests that Japan is finally starting to emerge from the technical recession triggered by a drop in consumer demand during the COVID-19 pandemic.
One might think this is a favorable signal for the yen, and the Japanese currency should surge. However, on Wednesday morning, JPY continues to fall against its American rival.
Analysts attribute traders' pessimism about the yen to existing risks to Japan's GDP. Signs of recession in the US, Europe, and China significantly darken the prospects for Japan's economy, which is primarily dependent on exports.
"Consumption will continue to underpin growth as removal of COVID curbs will boost tourism and service spending. But the economic recovery will be moderate as weak overseas demand will weigh on exports. It will be a tug-of-war between robust domestic demand and sluggish exports," noted Yoshiki Shinke, chief economist at the Dai-ichi Life Research Institute.
Japan's Minister of Economy, Shigeyuki Goto, also forecasted moderate GDP growth. This morning, the official also pointed out the increasing risks of a global recession, which could negatively impact the country's economy.
The weak recovery of economic growth in Japan is a strong argument for the BOJ to continue its ultra-loose monetary policy, which is a negative factor for the yen.
Meanwhile, analysts warn that the JPY's position could wobble even more towards the end of the week if the market sees a noticeable easing of inflationary pressure in the country.
On Friday, May 19, Japan's national consumer price index for April is expected to be published. The overall CPI is forecast to decrease year-on-year from 3.2% to 2.5%, and core inflation will slow from 3.8% to 3.4%.
A cooler consumer price growth may indicate signs of disinflation in the country and further convince the BOJ that high inflation is temporary and does not require a solution in the form of monetary policy normalization.
Experts warn that the strengthening of the market's dovish sentiment regarding the Bank of Japan's future monetary course risks sending the yen into a deep tailspin in the coming days.
From a technical perspective, the dollar bulls currently have the upper hand. If they manage to settle firmly above Tuesday's high of 136.68 today, their next target will be the high of 137.10 from March 2nd, followed by the two-month high of 137.91.
On the other hand, if the asset falls below the May 10th high of 135.47, this could significantly strengthen the bears' position. This would pave a fast track to the May 11th high of 134.84 and the May 11th low of 133.74.
