What's been driving the stronger JPY and will it continue?

Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday the 21st of February 2025. And joining me to pose some questions on the financial market themes for the week ahead is Simon Mays, Head of UK, Ireland and Switzerland Corporate Sales.

The following podcast is intended for professional investors and eligible counterparties only, and not for retail clients. Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Hi Lee, thank you very much for taking some time at the end of a busy week for you I know.

I wanted to start focusing on Japan, if that's okay. Obviously, we had the inflation data overnight, a higher headline inflation figure. Inflation in Japan has been something that's been focused on a lot over the years of Arbonomics and it looks like maybe finally we're getting some persistent higher inflation.

So maybe you could talk us through your views on the breakdown of the inflation figures and whether this is here to stay. Yeah, hi Simon. Yeah, as we saw overnight, the latest inflation data from Japan for January did show headline inflation picking up to 4%, so moving further above the BOJ's target.

The main kind of driver for that though was a surge in fresh food prices, which lifted the headline rate. Having said that, even if you would kind of strip out some of those kind of factors and just look at the kind of core inflation measures or services inflation, they're still growing kind of solidly at the moment. I think the general kind of gist of the report is certainly supportive for the BOJ's view that inflation is becoming more sustainable in Japan and should give the BOJ more confidence to continue normalizing policy.

So alongside the stronger data that we've had as well in terms of the economy we saw growth in the second half of last year was much stronger than expected. So the fundamentals are certainly suggesting that there's room there for the BOJ to keep raising rates and it supports our view that we think they'll hike again by the July policy meeting. That's pretty much a strong consensus view now amongst market participants.

And I think that kind of policy divergence story where the BOJ is raising rates at the start of this year while other central banks like the ECB, Bank of England, are still cutting rates, that narrowing of the yield differential between Japan and the rest of the world, that's certainly encouraging a strong yen. And I think to us is the main reason why the yen has been the best performing G10 currency this year. As we've seen this week, dollar yen again is kind of threatening to break back below the 150 level.

So part of that story is the broader base dollar weakness that we've seen. But obviously with the yields in Japan still pushing higher, that's contributing to broad-based yen strength as well. With Japan obviously slightly different to many because we've got a very high debt to GDP ratio.

How much does that play into what officials will think around inflation at the moment in Japan? Yeah, like we did see certainly overnight the first signs of maybe discomfort over the speed of the move that we've seen higher recently in Japanese yields. So if we look at say the 10-year JGB yield since kind of towards the end of last month, the 10-year JGB yield has risen by about 25 basis points, which is quite a big move for 10-year JGB yields and hit a high of 1.47% overnight.

So we did see some first signs of pushback against the pace of the move overnight where both Prime Minister Shibu and the finance minister in Japan did indicate some concern that if yields keep moving higher, as we've seen, that's going to obviously increase the financing costs of the government. Like I say, the high debt levels there in Japan make it more difficult for Japan to stomach higher yields. We also saw as well some comments from BOJ Governor Ueda when he's asked in parliament about higher yields.

He did indicate that the BOJ would be willing to step in and support the JGB market if we were to continue to see, I guess, unwanted moves higher in market yields. Obviously, with the BOJ hiking rates, they're obviously willing for yields to go higher. But obviously, if the pace of the move becomes more disruptive and starts to threaten financial stability in Japan, like we saw back in kind of August of last year, then they could take action to step in and slow the move higher in yields.

So that, I think, has taken some of the upward momentum out the move higher in yields in the yen at the end of this week. But I guess it remains to be seen whether that remains the case next week. I guess those comments also put a bit of a break on the dollar yen move lower as well.

We've had the yen strength based on domestic things as well as the US dollar weakness recently, which is, I guess, based on slightly more comfort on Trump sanctions and tariffs. So on that basis, which do you think have been the more important drivers for dollar yen moves? And do you expect the dollar generally to keep weakening?

Yeah, I think on the broader dollar story, like you say, it's been weakening now. I think this is the third consecutive week in a row that we've seen the dollar index weaken. To us, that does reflect some kind of optimism amongst market participants that maybe the worst of Trump's tariffs won't be implemented as people had feared.

There were some comments just the other day where Trump suggested even the possibility of having a trade deal with China. Just looking back at what happened during the first term, it took a number of years of escalating tariff hikes between China and the US before they got to a trade deal in early 2020. So he's already talking about the possibility of a trade deal at the start of his second term, which potentially increased the risk or the likelihood that we don't see the trade conflict escalating maybe as much as people are fearing between the US and China, although I would stress that it's still very early days and you can't really base such judgments off just one comment from Trump.

And then on the other hand, we'd also still be wary of the risks that you will follow through with some of these more aggressive tariff hikes. They're certainly mounting up now, the 25% tariff threat to put in place on automobiles, semiconductors, and pharmaceuticals from the 1st of April. Still, we have the outstanding tariff threat, 25% on Mexico and Canada.

And then as well, on top of that, we've got these reciprocal tariff hike plans, which are going to be formulated over the next couple of months, which could potentially be bigger than people are expecting if he looks to offset things like VAT rates that are applied in countries like here in Europe on imports from the US. So that as well could be coming into play in early April. So we think certainly over the next couple of months, around early April, this could be a big pivot point for the dollar more broadly.

If we do see some of these more aggressive tariff hikes put in place, that's going to be a lot more disruptive for global trade and the economy. And we could see the dollar bounce back more strongly in the second quarter. I guess on the more positive side, though, if he keeps watering down these tariff plans or delaying and pushing them back, then that's just going to further encourage markets to think that he doesn't really, or isn't really serious about putting them in place.

And that could then open the door up for some further dollar weakness. I'm sure whatever happens, there'll be plenty of curveballs. I'm not sure, I'm sorry.

Yeah, thank you very much for your thoughts today. Have a great weekend. Thank you.

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