Wider spreads to lift USD/JPY to 118.00 this year – Scotiabank

Central bank policy normalization – or lack of it – and monetary policy differentials are the main reasons why the USD/JPY is set to race higher towards the 118 level this year, in the opinion of economists at Scotiabank.

Gains in the USD unlikely to encounter verbal intervention from officials in Washington or Tokyo

“We expect the Fed to tighten monetary policy aggressively and look for the Fed funds rate to reach 2.00% this year to combat more persistent and entrenched inflationary pressures. Meanwhile, the Bank of Japan (BoJ) is unlikely to shift monetary policy any time soon.

“We expect rates to rise in the US whereas Japanese government bond yields are poised to remain extremely low. We forecast US 10Y bond yields reaching 2.40% this year and to hold at or a little above that point in 2023. In contrast, JGB yields are poised to remain more or less flat this year (0.14%) and rise just 3bps from that to 0.16% in 2023, according to the Bloomberg survey.”

“Our correlation studies suggest the influence of longer-term yield spreads on USDJPY is rising again. The 5-year and 10-year spread correlations with spot are holding at 60% currently while the 2Y spread correlation remains a relatively soft 46%. Wider spreads will lift the USD.” 

“A higher USD/JPY rate would likely suit both the US and Japan at the moment. A firmer dollar helps curb imported inflationary pressures into the US while Japan’s exporter base will welcome a weaker exchange rate.”

“The consensus anticipates little movement in the JPY this year or next (116 forecast for both end-2022 and end-2023) whereas we see more upside risk to 118 this year and 120 in 2023.”