BNY’s Geoff Yu notes that USD/JPY has broken above 160.00 with only a muted response from Japanese authorities, while cross-border flows into Japanese assets continue to weaken. He highlights concerns over disorderly bond moves and embedded inflation expectations, but argues that policymakers still see limited benefit in a stronger Japanese Yen (JPY), implying constrained JPY appreciation despite potential Bank of Japan (BoJ) tightening.

Authorities cautious as USD/JPY holds above 160

"Six weeks after a “final warning” against FX markets in USD/JPY, the key 160.00 level is being breached without much incident, and the reaction from Japanese authorities has been relatively muted. Moderate Bank of Japan (BoJ) tightening and a steady drift higher in nominal yields is seen as sufficient for now. But that could change if the Federal Reserve outlook is repriced – even a marginally hawkish FOMC result next week could negate what the BoJ delivers."

"Meanwhile, our flows indicate that there is ongoing deterioration in asset flows by cross-border investors. Around mid-May, Japanese government bonds (JGBs), the JPY and cash-equivalent instruments were all net sold for the first time this year. This was hardly reassuring for authorities trying to stabilize the JPY amid currency pressures across the region’s net-energy importers."

"Governor Kazuo Ueda’s recusal from the upcoming meeting has added to the uncertainty around the policy outcome, though we don’t see it changing things materially. The market appears positioned for dovish surprises. Reports already point to the end of BoJ’s tapering of JGB purchases as a potential decision, and this would be sufficient to negate any tightening move."

"The BoJ and Ministry of Finance are evidently concerned about the risk pf disorderly moves in government bond markets, with inflation expectations becoming embedded. However, authorities are far from convinced that having a stronger currency is an asset in managing such moves, at least amid a supply shock that damages Japan’s balance of payments."

"Hence, this “one step forward (on rates), half a step back (on balance sheet operations)” remains the preferred path, but it’s unlikely to leave much room for JPY strength, particularly as intervention will be used sparingly."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)