The Japanese Yen is echoing memories of last year when monetary policy clashed with fiscal policy. A recent shift in the Japanese government has led to a divergence between the country’s fiscal policy and its monetary policy. This has triggered a collapse in the Yen, driving it 6% lower over the past 2 months.
However, with the Yen approaching previous intervention levels and BOJ action, the possibility of a sharp reversal is rising.
The Clash of Fiscal and Monetary Policy
Japan’s central bank and government are diverging sharply, with BOJ turning hawkish while the new Japanese government paves a dovish path.
In the October policy meeting, 8 of 13 BOJ board members argued that conditions for a near-term rate hike were in place.
While Governor Ueda initially stated that the BoJ would look towards the spring wage negotiations before deciding on a rate hike, recent BoJ member statements signal that this may be shifting. Further, labor unions recently stated that they will push for bumper hikes.
After ending a decade of ultra-easy policy only last year – lifting the short-term rate to 0.5% in January – the BOJ is now widely expected to tighten further soon. Recent trends suggest that this may take place in the very near term, perhaps over the next 2 meetings – in December or January.
By contrast, Prime Minister Sanae Takaichi’s new government is pursuing an aggressively expansionary fiscal path. In November, it approved a JPY 21.3 trillion stimulus package – Japan’s largest since the pandemic – including JPY 17.7 trillion in spending and JPY 2.7 trillion in tax cuts. We covered this in a previous note in detail.
As fiscal policy clashes with monetary policy, the yen has slid to 10-month lows, and long-term JGB yields jumped to multi-year highs. Loose fiscal policy in Japan runs the risk of straining Japan’s already strained debt levels and clashing with the monetary policy and rising bond yields that make the additional debt cost even higher.
These developments have sent Japanese bond yields sharply higher. Conditions in the JGB markets could get even worse due to a dangerous feedback loop between weak auctions and rising yields as stated by economists at MUFG.
The yen is a flashpoint in this scenario. USD/JPY has dropped to levels not seen since the start of the year, perilously close to the USD/JPY rate of 160 that previously saw authorities step in with currency intervention in July 2024.
Source: CME CVOL
With yen option implied volatility still low and hedged positions light, the FX market seems ready to test authorities again. Notably, past episodes offer a cautionary tale: when the BOJ last tightened amid a weak yen, the currency rebounded sharply.
For example, in July 2024, the BOJ raised rates to 0.25% in tandem with the government’s yen-buying intervention, and the yen subsequently jumped from its lows. Today’s near-intervention yen levels and Fed-distorted currency flows could set the stage for a similar outcome. A BOJ move might quickly trigger significant yen appreciation and a repricing of risk, echoing the past.
Options markets are suggesting early signals of participants positioning for such a move, with a recent buildup in call positions over the past week in the December contract.
Source: CME QuikStrike
BOJ to Follow Fed Action in December
Source: CME FedWatch
The other side of the USD/JPY pair is the dollar – which has recently seen its own rollercoaster. In October, market expectations of a rate cut by the Fed in December were high. Those expectations shifted rapidly to signal a hold, but are now back to signaling a rate cut.
This is crucial as Yen positioning is heavily impacted by the Yen carry trade which relies on the yield differential between the US and Japan. A rate cut will reduce this differential and support the Yen. While uncertainty on both Fed and BoJ remain, an action by both central banks – a rate hike by the BoJ and a rate cut by the Fed could together provide ample support to the Yen and override the uncertainty related to the fiscal policy.
It is important to note that the December FOMC meeting takes place one week before the BoJ meeting, so any BoJ action in December may factor in the Fed’s decision. A reasonable compromise for the BoJ may be to delay a hike if the Fed chooses to cut rates. This scenario would lead to the conservative scenario in the chart above.
Historical Trade Setup
The current juncture recalls mid-2024. Then, a weak yen and rising yields prompted a swift BOJ hike and intervention, which quickly reversed currency moves and repriced bond risk. In plain terms, the clash of loose fiscal and tighter monetary stances is a dangerous mix. If history is any guide, a near-term BoJ hike in this environment could lead to an abrupt yen rally (testing the previous intervention band) and renewed stress in the JGB market.
At the same time, new risks are materializing for the Yen that could lead performance to diverge from historical trends.
Entry: 0.006394
Exit: 0.007035
Profit at Exit: 0.000641 [0.007035-0.006394] x 12,500,000 [Contract Size] = USD 8,012.50
Max Drawdown: 0.006242
Loss at Max Drawdown: 0.000152 [0.006242-0.006394] x 12,500,000 [Contract Size] = -USD 1,900
Traders could also express this view using the Micro JPY/USD contract which provides exposure to 1/10th the size of the full contract.
This content is sponsored.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs at tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
However, with the Yen approaching previous intervention levels and BOJ action, the possibility of a sharp reversal is rising.
The Clash of Fiscal and Monetary Policy
Japan’s central bank and government are diverging sharply, with BOJ turning hawkish while the new Japanese government paves a dovish path.
In the October policy meeting, 8 of 13 BOJ board members argued that conditions for a near-term rate hike were in place.
While Governor Ueda initially stated that the BoJ would look towards the spring wage negotiations before deciding on a rate hike, recent BoJ member statements signal that this may be shifting. Further, labor unions recently stated that they will push for bumper hikes.
After ending a decade of ultra-easy policy only last year – lifting the short-term rate to 0.5% in January – the BOJ is now widely expected to tighten further soon. Recent trends suggest that this may take place in the very near term, perhaps over the next 2 meetings – in December or January.
By contrast, Prime Minister Sanae Takaichi’s new government is pursuing an aggressively expansionary fiscal path. In November, it approved a JPY 21.3 trillion stimulus package – Japan’s largest since the pandemic – including JPY 17.7 trillion in spending and JPY 2.7 trillion in tax cuts. We covered this in a previous note in detail.
As fiscal policy clashes with monetary policy, the yen has slid to 10-month lows, and long-term JGB yields jumped to multi-year highs. Loose fiscal policy in Japan runs the risk of straining Japan’s already strained debt levels and clashing with the monetary policy and rising bond yields that make the additional debt cost even higher.
These developments have sent Japanese bond yields sharply higher. Conditions in the JGB markets could get even worse due to a dangerous feedback loop between weak auctions and rising yields as stated by economists at MUFG.
The yen is a flashpoint in this scenario. USD/JPY has dropped to levels not seen since the start of the year, perilously close to the USD/JPY rate of 160 that previously saw authorities step in with currency intervention in July 2024.
Source: CME CVOL
With yen option implied volatility still low and hedged positions light, the FX market seems ready to test authorities again. Notably, past episodes offer a cautionary tale: when the BOJ last tightened amid a weak yen, the currency rebounded sharply.
For example, in July 2024, the BOJ raised rates to 0.25% in tandem with the government’s yen-buying intervention, and the yen subsequently jumped from its lows. Today’s near-intervention yen levels and Fed-distorted currency flows could set the stage for a similar outcome. A BOJ move might quickly trigger significant yen appreciation and a repricing of risk, echoing the past.
Options markets are suggesting early signals of participants positioning for such a move, with a recent buildup in call positions over the past week in the December contract.
Source: CME QuikStrike
BOJ to Follow Fed Action in December
Source: CME FedWatch
The other side of the USD/JPY pair is the dollar – which has recently seen its own rollercoaster. In October, market expectations of a rate cut by the Fed in December were high. Those expectations shifted rapidly to signal a hold, but are now back to signaling a rate cut.
This is crucial as Yen positioning is heavily impacted by the Yen carry trade which relies on the yield differential between the US and Japan. A rate cut will reduce this differential and support the Yen. While uncertainty on both Fed and BoJ remain, an action by both central banks – a rate hike by the BoJ and a rate cut by the Fed could together provide ample support to the Yen and override the uncertainty related to the fiscal policy.
It is important to note that the December FOMC meeting takes place one week before the BoJ meeting, so any BoJ action in December may factor in the Fed’s decision. A reasonable compromise for the BoJ may be to delay a hike if the Fed chooses to cut rates. This scenario would lead to the conservative scenario in the chart above.
Historical Trade Setup
The current juncture recalls mid-2024. Then, a weak yen and rising yields prompted a swift BOJ hike and intervention, which quickly reversed currency moves and repriced bond risk. In plain terms, the clash of loose fiscal and tighter monetary stances is a dangerous mix. If history is any guide, a near-term BoJ hike in this environment could lead to an abrupt yen rally (testing the previous intervention band) and renewed stress in the JGB market.
At the same time, new risks are materializing for the Yen that could lead performance to diverge from historical trends.
Entry: 0.006394
Exit: 0.007035
Profit at Exit: 0.000641 [0.007035-0.006394] x 12,500,000 [Contract Size] = USD 8,012.50
Max Drawdown: 0.006242
Loss at Max Drawdown: 0.000152 [0.006242-0.006394] x 12,500,000 [Contract Size] = -USD 1,900
Traders could also express this view using the Micro JPY/USD contract which provides exposure to 1/10th the size of the full contract.
This content is sponsored.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs at tradingview.com/cme.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Full Disclaimer - linktr.ee/mintfinance
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.
Full Disclaimer - linktr.ee/mintfinance
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.