The Japanese yen has tried to regain its footing early on Thursday. USD/JPY is likely to extend its uptrend, despite the ongoing downward correction of USD.
Why is JPY on the decline?
The yen's massive sell-off is continuing. On Wednesday, JPY hit 144.99 against USD, its lowest level since 1998.
Since January, JPY slumped against USD by more than 19% in its worst performance on record.
Furthermore, the Japanese yen is now considered to be the worst performing currency out of all G10 currencies due to the unwavering dovish tactics of the Bank of Japan.
While other regulators are actively tackling inflation by increasing interest rates, the BOJ is keeping interest rates low.
The Japanese central bank now has a policy gap with other major central banks, particularly the Federal Reserve.
As part of its current monetary tightening cycle, the Fed has already hiked interest rates 4 times.
The Fed funds rate is currently in a target range of 2.25% to 2.50%, while the BOJ's interest rate is at 0.1%.
The US regulator is now getting ready for another interest rate hike. With inflation remaining high and the economy being relative stable, the markets are pricing in a 79% probability of another 75 bps move.
Traders are confident that the Fed would keep its iron-clad resolve to carry out their hawkish policy course. This in turn has pushed up the yield of US Treasury bonds, sending the yen into a tailspin.
JPY is highly sensitive to fluctuations in the yield on 10 year US Treasury bonds because the Bank of Japan is keeping the 10-year government bond yield around 0% to stimulate the economy.
Temporary respite
Early on Thursday, the yen regained 144 as the US dollar lost its upward momentum and came under pressure from several factors.
Market players are awaiting the monetary policy decision by the European Central Bank, which is due today. Traders are anxious that the ECB could decide to follow a more hawkish course and increase interest rates by 75 basis points.
Furthermore, growing risk sentiment has put additional pressure on the US dollar. The US stock market advanced on the news of falling US trade deficit. The deficit narrowed in July by more thah 12% to $70.7 billion from $80.9 billion in the previous month.
In addition, Japan's GDP increased by 3.5% in Q2 2022, above the expected 2.2% rise. The data pushed down USD/JPY early on Thursday.
While USD/JPY might have ended up in a perfect storm earlier today, analysts are still bullish on the pair.
A growing gap between Fed and BOJ interest rates is set to remain a key bullish factor for USD/JPY.
How low can the yen fall?
After USD/JPY tested 145 yesterday, many analysts have worsened their outlooks on the Japanese currency.
USD/JPY is now clearly overbought. However, FX strategists at UOB expect the pair's uptrend to continue in the near future.
At this point, USD/JPY bulls need a strong impulse. Today's events on the economic calendar could very well send the pair upward.
Today, traders will pay attention to the speech of Fed chairman Jerome Powell at the Cato Institute conference.
If Powell manages to further convince the markets of the Fed's aggressive hawkish intentions, it could boost the US dollar yet again.
Akira Moroga, analyst at Aozora Bank in Tokyo, noted that USD/JPY could reach 145 even without any fresh catalyst as its recent performance was not caused by any clear factors.
Moroga pointed out that if the Japanese yen continues to devalue, Japanese officials could actually intervene to keep JPY from falling even further.
However, even radical measures would be unlikely to reverse the overall trend. Until the Fed slows down the pace of its interest rate hikes and yield on US Treasury bonds falls, the yen would remain weak.
Some analysts believe the Japanese yen could fall against the US dollar to its all-time low of 147.70, which it hit in 1998.
Analysts at Credit Suisse see JPY sink to 153 against USD in the long-run.
