Yesterday, the USD/JPY pair collapsed after the publication of weaker-than-expected US economic data. The statistics significantly worsened the interest rate forecast on the eve of the Federal Reserve's symposium in Jackson Hole. If tomorrow Jerome Powell indicates that the market was mistaken, this could rejuvenate the US dollar. However, a sharp recovery of the greenback may turn into a real disaster for the USD/JPY pair.
USD/JPY's steep decline
On Wednesday, USD/JPY showed the worst performance among all dollar majors. The rate plummeted by more than 0.7%, down to the August 14 low of 144.845.
Last week, on the contrary, the USD/JPY pair surged and traded at a 9-month high of 146.565, as traders were actively betting on the continuation of the Fed's aggressive policy.
However, yesterday, investors revised their forecasts regarding the future policy of the US central bank. The trigger for this was the publication of US economic activity data from S&P Global for August.
The statistics showed that this month, business activity in the US approached stagnation, showing the weakest growth since February. The composite index, which accounts for both the manufacturing and services sectors, dropped to 50.4 in August from 52 in July.
"This data threatens the 'US exceptionalism' narrative that the market has been trading on for the last couple of weeks," said analyst Michael Brown. "Recently, recession fears have considerably waned, and the GDP growth forecast was raised. However, yesterday's statistics painted a cooler picture of the state of the US economy."
The looming risk of a recession once again weakened the market's hawkish expectations on the eve of the annual Federal Reserve symposium in Jackson Hole. This led to a sharp drop in the yield of 10-year US Treasuries.
Yesterday, the indicator dropped by 13 bp, to 4.198%, marking its most significant one-day fall since May. The sharp decline in the yield of US bonds put significant pressure on the USD/JPY pair.
To reverse current market trends, traders must see a significant shift in the Fed's forecasts. If tomorrow, during his speech, the Fed Chairman hints at an additional round of tightening this year and also emphasizes the need to keep rates higher for longer, this should strengthen the US dollar.
Most analysts are now leaning towards this scenario. Predictions suggest that on Friday, the greenback may show parabolic growth in all directions, including the USD/JPY asset.
Experts warn that traders dealing with the USD/JPY major should be extremely cautious in the near future. If the rate recovery is overly sharp, it will most likely provoke currency intervention from Tokyo.
How likely is FX intervention?
On Thursday morning, the USD/JPY pair began an upward correction. At the time of writing, the quote had increased by 0.24% and settled above the crucial level of 145. Until recently, many market participants perceived this as a red line.
In the fall of the previous year, Japan conducted two interventions to buy the yen when it fell to critically low levels against the US dollar. One such level was precisely the 145 threshold.
In recent weeks, the dollar/yen pair has crossed this line multiple times. Yet, every time, Japanese authorities maintained their composure, limiting their reactions to routine threats against currency speculators.
Given this, some analysts have concluded that the intervention threshold may have shifted to a higher level of 150. This would pave the way for further growth of the USD/JPY pair.
However, not all experts hold this view. Some believe that this time, the focus of the monetary authorities won't be on a specific threshold but rather on the pace of JPY's decline.
It is difficult to say which pace of the yen's drop might be deemed extreme. However, referring to last year's figures might help.
Three weeks before October 21, 2022, when Japan conducted its second yen-buying intervention, the yen weakened by 4.8% against the dollar. By comparison, this month, the Japanese currency has only depreciated by 1.5% against its American counterpart.
Nevertheless, recent statements by high-ranking Japanese officials indicate that the yen's ongoing depreciation is a major concern for the government.
Yesterday, Hiromi Yamaji, head of the Japan Exchange Group, pointed out that the recent drop in the JPY's value had already resulted in negative economic side effects, primarily increased import costs, especially for key energy sources like oil.
In his view, the authorities currently have two solutions: either tighten their monetary policy or intervene in the currency market.
Since Japan hasn't yet met a key prerequisite for the first option (achieving stable 2% inflation), some experts believe Japan might opt for the latter.
If tomorrow's speech by Jerome Powell, the head of the Federal Reserve, turns out hawkish and induces market turbulence, there is a high likelihood that Tokyo won't passively watch the yen's free fall this time around. Traders should be on their toes and brace themselves for potential intervention.
