The desk posits that recent rate checks in USDJPY are pivotal not only for the yen but also for the broader dollar landscape. Per the full note from BofA Global Research, the discussion highlights the historical context of FX interventions and their effectiveness, particularly in light of Japan's upcoming elections. The current technical levels suggest a critical juncture for USDJPY, which traders should monitor closely as it could influence sentiment across other currency pairs. Our consensus target for USDJPY aligns with a cautious outlook, reflecting the nuanced dynamics at play.
What the desk is arguing
BofA suggests that the current USD/JPY rate checks may be instrumental in influencing currency movements not just for the yen, but also for the dollar. They argue that past lessons on FX interventions can offer valuable insights into the effectiveness of current policies, particularly as they consider the implications of upcoming political events in Japan and the USD outlook.
Furthermore, BofA discusses the role of the US government’s FX policy amid these technical levels being tested in the currency markets. This framing implicitly challenges the notion that interventions are always beneficial, urging a more nuanced view based on historical precedents.
01BofA emphasizes the importance of USD/JPY rate checks on broader dollar movements.
02The discussion highlights historical insights regarding FX interventions.
03Political implications in Japan may further influence the yen's outlook.
Market implications
The ongoing discourse about rate checks in USD/JPY may spark volatility in currency pairs, particularly if market expectations shift based on intervention strategies. With BofA's targets for March and December 2026 aligning with a bullish view on JPY at 154.0000 and 147.0000 respectively, the focus will be on how these interventions could alter trading sentiment and technical indicators.
Risks to this view
Key risks revolve around the potential ineffectiveness of FX interventions, which may not yield the intended results or could exacerbate market volatility. Additionally, the uncertainty surrounding Japan’s upcoming elections could further complicate the currency landscape, pushing investors towards cautious stances.
Hello, and welcome to Global Research Unlocked, the interest rate and FX series. This podcast is based on our weekly client conference call where our strategists along with guests from other parts of BofA Global Research discuss the most topical and pressing questions faced by our market. I'm Ralf Preusser, head of Global G10 rates and FX strategy.
Today's Friday, 30th of January, I am joined by Adarsh Sinha, global head of G10 FX strategy, Alex Cohen from the G10 FX strategy team, and Paul Sianna, global head of technical strategy. Thank you all for joining. First of all, Adarsh, let's start with you and let's start with dollar-yen, which led the dollar sell-off over the past week.
The words that have been mentioned in context of the sell-off are rate checks. Could you maybe start off with explaining what those are and why they had such a big impact? Sure.
Thanks, Ralf. It sounds like a simple question, but I was surprised how often I got asked this during the course of the week, so I think it's worth clarifying exactly what this means. So rate checks are usually when a central bank calls a dealer or several dealers and asks for a two-way price in a certain size, usually a meaningful size, but importantly, they don't execute.
So what this usually means is it usually precedes intervention and is effectively a signaling action by a central bank. That intervention is imminent. Now, on the question of why it had a big impact, I think it's important to break it down into the two types of rate checks that we had.
So the rate check from the Bank of Japan on behalf of the Ministry of Finance, and I would add the reported rate check because, of course, they haven't confirmed it, this usually has a pretty small impact because it has happened in the past. And usually before the rate check, the Ministry of Finance kind of escalates its verbal rhetoric. The signal intervention is near.
So by the time we get to the actual rate check, it's actually not that much of a surprise. So it's happened a few times before. Usually dollar-yen does fall a little bit on it, but not that much.
And that's precisely what happened last week on Friday. There were reports of a rate check, dollar-yen fell a little bit during Asia hours, but not that much. The big impact actually came during the New York trading hours when the New York Fed checked rates.
And this had a much bigger impact, which I'm sure we'll discuss later, because this is quite unusual from a historical perspective. What's the risk of a broader yen carry trade unwind, which could spill over to other markets such as what we saw in July, August 2024, and maybe also start off with what we mean when we talk about the yen carry trade? Because again, it seems to be one of those terms that means many different things to many different people.
Yeah, absolutely. It's a tricky concept. And it's a hard thing to measure, partly because of lack of data, but partly how you define a yen carry trade.
The way I would think about a yen carry trade is essentially you're borrowing in yen to invest for speculative purposes. To me, that would be the simple definition. And there can be many ways these carry trades are conducted.
So we have certain measures that we look at to kind of estimate how large the carry trade is. So for instance, we'd look at yen bond issuance by foreign firms, which might not be speculative in nature, but certainly the motivation here is the low funding cost in Japan. We would look at CFTC positioning data, which is definitely speculative.
So anyone who short the yen there is doing it for speculative reasons. We can also look at inter-office yen borrowing by foreign banks on the assumption that this is ending up eventually with investors that are borrowing yen for investment purposes. So there's no perfect measure, but there are some of these measures that we look at and we aggregate.
And the key point here is when we look at this aggregate measure, we don't see signs that the yen funded carry trade is especially large from a historical perspective and not as large as we saw in the middle of 2024, when there certainly was a big carry unwind and the yen appreciation did spill over to other asset classes. So never rule it out, but I'd be less worried about it now than we might have been in 2024. Thanks, Sadash.
Paul, one of the other spillovers that people worry about is the one that's coming out of JDBs. We've seen a decent sell-off in particular in the long end. What's your technical take on JDBs and, I guess, broader rate markets?
Higher highs and higher lows. That's the basic definition of an uptrend, and that's what we've had in the JDB yield charts since they double-bottomed back from 2016 to about 2020. So it's hard to say fight to take because that's the persistent trend at hand.
When I look at something like the 30-year JDB yield chart, then what we could say is yield discovery or price discovery. It's all-time highs and yields. If we pivot down a little bit on the term and we look at something like the 10-year, that yield is also at generational highs, it almost seems like, above the 2000 peak and approaching a whipsaw moment back in 1999, which is about 2.5%.
With that said, it just looks like a massive basing pattern and the pressure for yields to rise in this secular kind of story is there. Is there scenarios where this ends violently, kind of like it did in 1999? Sure, that is a possibility, but we don't see that yet.
So higher highs and higher lows in JDB yield. That's the trend. Thanks, Paul.
Alex, let's come to you for reasons that will be obvious quite quickly. Adarsh already mentioned the fact that one of the things that broadened the dollar sell-off was the fact that we saw a rate check not just from the Bank of Japan, but also from the New York Fed. Now, you were on that FX desk in your previous life.
What is the likely motivation behind it, assuming it has happened, and does it signal the possibility of maybe coordinated intervention? Yeah, thanks, Ralph. Well, it's certainly been interesting to me to watch all this from afar here.
Just sticking with dollar-yen, certainly things like any sort of disorderly extreme move or rapid move higher in the pair is understandably undesirable both for Japan and for the US. It's both the levels of dollar-yen, which we're getting quite high, but also the pace that matters as well. Now, I think the overall odds of a coordinated intervention between Japan and the US are still low in absolute sense.
It's clearly less low now than it was, say, at this time last week before those rate checks happened. So those rate checks from the US side are indeed quite rare. And I'm not even sure that they've happened probably since the 90s, but this has not really been a thing.
Now, what we've seen overall, stepping back a bit, is the US administration and the Treasury do seemingly have a more willingness to get involved in markets if it suits their needs. And Japan here seems relatively more cooperative with the US on things like trade, things like inward investment into the US. And the administration, I would say, clearly has a preference for...
We know lower rates, they're very vocal on that. And I believe they still have a preference for a weaker dollar, despite even some reiterations of the strong dollar policy. Dollar-yen is clearly the standout here when it comes to the G10 world.
So if that wasn't the case, they likely wouldn't even have considered these rate checks. But again, it is quite rare, especially for a key reason, just being that a lot of the move in dollar-yen does relate to political factors in Japan. So in that sense, there is some more local reason for why the pair is standing out versus the dollar more broadly.
But doing these rate checks, it does put some credibility on the line for the Treasury Department. So if the dollar-yen pair does retrace higher, following through on this definitely is something that the market really needs to take seriously. Thanks, Alex.
Adarsh, coming back to you, obviously, one of the team's calls has been to be structurally bearish-yen. Do these events change our view? And how should we think about the upcoming snap election in Japan in that context?
Sure. Thanks, Ralph. So I think taking a step back, why have we been structurally bearish on the yen?
I think there are multiple factors, but if there's one thing I'd flag, it's structural outflows from Japanese corporates and Japanese households. And the reason we call this structural is essentially Japan has been a cash-rich society for decades. And it was okay when inflation was zero, but inflation is plainly not zero.
So for the past few years, we've been making the case that Japanese corporates and households would diversify their balance sheet away from cash into financial assets. And when you look at the data, the bulk of diversification has been into foreign assets. So Japanese companies buying foreign companies and Japanese households investing mainly in foreign equities via torsion funds, helped by certain tax exemptions that they get on that.
So that's the reason we've had a structurally bearish view. Now, intervention, of course, can lead to yen strength, but the pattern of intervention in Japan tends to be one-off. So intervention by itself doesn't change our structurally bearish view.
So what does change it? I think the first thing that would change it was if we saw signs of the structural outflow slowing. This is something that we track very closely on a daily basis.
And the short answer is we're not seeing signs of this outflow slowing, if anything, to start the year. The outflow has actually accelerated. And in terms of the election, I guess the election is another reason to be bearish on the yen.
The assumption, I think, from most investors is if Takeuchi called a snap election, she hopes to strengthen her majority and perhaps achieve an outright majority in parliament, which would allow her and the party to pursue their pro-cyclical fiscal priorities. And that environment obviously should be bullish for equities. But given the fiscal angle, it potentially could be bearish for both JGBs and the Japanese yen.
So we think if that's the outcome of the election, it's probably yen bearish near term. The one thing I would add to that in terms of intervention risk, we think it's very unlikely that the government wants dollar yen, say, well below 150 heading into the election just because of the negative spillover that could have to Japanese equities. And then another thing that might change our view, but it's kind of a longer horizon factor, is if Takeuchi and the LDP do win an outright majority, political stability is something we haven't seen in Japan for a long time.
And perhaps over the medium term, not immediately, it can help stabilize yen-denominated assets and therefore stem the structural weakness of the yen that we've seen for quite some time. But that's a story for another day. Thanks, Adash.
Paul, what are your thoughts on dollar yen as well as the broader dollar index? Sure. So, for a bigger picture, dollar yen back in 2021 and 2022 started to make some really significant upside breakouts where our secular target was high as 176.
We haven't got there yet. I still think there's potential in scenarios where we do. The price action that we've seen over the course of 2025 into 2026 has made some relevant upside breakouts that support exiting this consolidation phase from the last two years and potentially beginning a new cycle higher in dollar yen.
So, I'm of the view that there are still higher highs in dollar yen to come in the next couple of years. And whatever kind of happens in 2026 may be an opportunity to think about that view. As far as the dollar index goes, that's been a very choppy seven-month period where we've had bullish signals look bearish multiple times.
And this week was particularly interesting because it did break to a lower low for the cycle. So, I think we have to kind of step back and think about what that means for the medium and longer-term charts and see where the week, the month, and even this quarter ends to suggest if this last batch of bearish breaks has potential to follow through. My best guess is that in the short-term it probably does.
But in the medium-term, I think I still have a question mark on that. Thanks, Paul. Alex, sticking with the dollar index, it's decoupled a few times from rate differentials, including in this most recent price action.
It's quite reminiscent of April 2025, obviously on a smaller scale. What do you think has driven this aside from the intervention risk? Yeah, exactly, Ralph.
So, we haven't really seen the decoupling like this really since Liberation Day. And since then, and for the most of the end of last year, at least from a change perspective, the dollar was tracking pretty well with rate differentials. So, in my mind here, I think this is really the cleanest read of assessing any kind of U.S.-centric risk premium getting built into the market.
We've been focusing, of course, on this call on dollar-yen, but this all really kicked off with Greenland just a few short days before the rate check. And just like we saw last spring, when it is U.S. policy that is getting perceived to be relatively more, let's call it, antagonistic to many of its allies, the dollar does seem to serve as the relief valve here for financial markets. For context, I think it's been interesting, some of the contrasts between Liberation Day and what we're kind of looking at now, we're not really seeing the same equity reaction compared to last April.
Treasuries haven't sold off, and the dollar's decline has really been broad-based against EM and DM alike. So, it's not really risk-off, per se, it's not sell America, per se, and it's really being sort of felt in the FX market as this dollar risk premium. Now, at the same time, I think, you know, it's also probably worth noting here, even the bigger story is really gold and precious metals at large.
Now, maybe there's been some, you know, fairly sizable pullback today, but I don't think this story is going anywhere. So, even if there are these sort of dollar concerns, specifically versus other fiat currencies, you know, I would say the backdrop to all this is that there is this sort of fiscal concerns that are out there. These concerns are global, that is playing into what we're seeing in precious metals, in addition to some of the foreign policy type factors here.
And clearly, we're seeing, you know, a more activist world when it comes to things like risks of fiscal dominance. There's just more uncertainty there. And if there's this sort of broader reluctance to push rates higher, then the market, you know, is seeing this move in gold kind of go unopposed.
So, that's sort of another way to really assess what's happening with the US and for the dollar. Thank you, Alex. Paul, what are your thoughts on gold?
Parabolic, in a word. Silver as well. In those situations, the best thing a technician or trend follower can really do is leverage certain indicators that are trailing stop-like lines that follow price higher in a, you know, risk-mitigating way to try and stay in the trend as long as possible.
And, you know, once certain levels like that are hit, kind of like a CTA framework, we change the view or at least turn neutral. So, you know, the secular uptrend in gold and silver is up. And we're just trying to hold on as long as we can.
Thank you, Paul. Adarsh, turn your tack slightly. We've been tracking European asset manager hedging dynamics quite closely.
What's the likelihood that we see any changes there following recent events? Sure. Thank you, Ralph.
So, we have been tracking it closely, at least in terms of the official data, but with significant lags. So, when we look at country-level data of what European pension funds are doing in terms of the asset allocation and hedge ratios, this data comes out typically quarterly. It comes out monthly for Danish pension funds.
And, in fact, that's probably the only country where we saw a meaningful increase in hedge ratios in 2025. But outside of Denmark, there was actually very limited evidence of meaningful reallocation away from U.S. assets or higher FX hedge ratios. So, that's what the official data tells us with quite a bit of lag.
So, that's not going to tell us what's happening in real time. But I did have quite a few conversations with asset managers in Europe towards the end of last year around this topic of hedge ratios and why they hadn't gone up. And I think two main things came up.
Firstly, hedge costs were still high. And that was part of the reason that there was some reluctance to immediately increase hedge ratios, also because the dollar had been range-bound for several months. What this tells me is that, obviously, the magnitude and timing of Fed cuts will be important because that would reduce the hedge cost over time.
And if that does happen, I think asset managers, from a risk management standpoint, would be much more willing to step in and increase hedge ratios, i.e. sell the U.S. dollar. The other thing that came up was just kind of the internal process around increasing strategic hedge ratios tends to be fairly slow-moving. So, these usually are investment committee decisions that have to be approved by the board.
And therefore, they're subject to the timing of these investment committee meetings that can happen at different frequencies at different times of the year. So, again, it's very hard to time when these decisions will be made. But I think if you get some combination of lower hedge costs, the dollar breaking out of its range, as at least briefly it has, as well as the correlations, the positive correlation of the U.S. dollar to U.S. equity is being sustained over a period of time.
So, not just for one day or one week or a month, as we saw in April last year, but being sustained over a period of time where you see U.S. equity selling off and the dollar weakens. I think that combination will bolster the case for higher hedge ratios in 2026. And certainly, that's our base case and part of the reason we expect the euro to strengthen versus the U.S. dollar.
Just timing it is incredibly difficult. Thanks, Adarsh. Alex, last but certainly not least, President Trump has nominated Kevin Walsh as the new Fed chair.
How should we think about the dollar impact of that? So far, the market reaction has been fairly modest. We did get a small sell-off initially, which is more than reversed in the last hour or so.
I think part of that just has to do with, among many things, we've been watching this for a long time. I think the decision was fairly telegraphed at this point, you know, starting yesterday. So this wasn't really a shock or a surprise.
If anything, I just think the market is probably a bit relieved that some of this pageantry is now behind us and we can sort of focus on going forward. Now for the dollar, I think the real implication is really more of a medium-term than a short-term story here. Of course, any candidate for this job, we all know that they were needed to be sufficiently dovish when it comes to rate cuts.
We certainly believe that of Walsh as well. But for Walsh in particular, I think what's really going to come down to here is, you know, if future conditions in the market warrant some kind of ramp-up in balance sheet expansion, will he advocate for it or will he resist it, as he certainly has a history of doing? Or put another way, let's say, you know, in a hypothetical world, the Fed cuts by a significant amount, and the 10-year yield on the Treasury actually moves higher, as we sort of saw in September 2024.
What does he do in that scenario? So while he might sort of be perceived as more hawkish now when it comes to the balance sheet, will he oppose the administration when tested? Because we certainly know the administration has the desire for rates to be lower, and in particular, they focus a lot on the 10-year.
So I don't think this independence concerns are going away here, and this will be really what is the next test for the dollar, I think, but for now, I would say the implications are a bit more limited or contained, just with everything else going on, especially. At the same time, you know, I would also note, you know, Walsh is a former governor. I think he presumably has known Powell for a long time.
And another big question around all of this sort of transition period is, you know, what will Powell do after his chairship is up but his governorship still has a number of years to go? Personally, I think Powell will step away, and I think, you know, this should, on the margin, maybe push the balance of the committee a bit more in the dovish direction, as there are some questions, especially after the DOJ subpoena, that could actually motivate Powell to stick around further. So my personal view, and certainly there's a distribution of views here, but I think this makes it a bit more likely that Powell does step away when his chairship is up, and that should be a bit of a dovish signal.