What’s behind the correction lower for USD/JPY?

Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday the 29th of November 2024, and joining me to close some questions on the financial market themes for the week ahead is Seiko Katayoka-Fisher, Vice President from Japanese Customer Sales for EMEA in London. 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. Hi Seiko.

After strong gains in the weeks following the US election, US dollar has corrected lower over the past week. Do you expect this to continue? Yeah, like you said, we've seen quite an abrupt reversal of the dollar's recent gains from a kind of technical perspective.

At the end of last week, we did see the dollar index trying to kind of break out some multi-year highs above the 107 level, but obviously failed to sustain those levels. And over the past week, we've seen it drop back quite sharply below that key resistance level. So yeah, it certainly looks like the kind of upward momentum for the dollar and other Trump trades like higher yields have run out of upward momentum over the past week.

Even though we did see at the start of this week, President-elect Trump did threaten to impose 25% tariffs on all goods from Canada and Mexico, and also further hike tariffs on China by 10% at the start of his second term as president. So you'd have thought that could have provided additional impetus there for the dollar to strengthen further this week. But as we've seen, that's failed to materialize.

So certainly the price action in the near term does suggest at least some form of consolidation here close to recent highs for the dollar. We still don't think that the kind of upward trend will reverse on a sustainable basis. We just think this is more of a pullback after very strong gains in recent weeks.

In terms of other kind of key currencies that we've been watching this week, like I say, with Trump announcing those tariff threats for Canada and Mexico, we did see some bigger moves in the Canadian dollar and Mexican peso. Dollar-CAD initially was up about one and a half percent, and dollar-max up by around two and a half percent. But as we've seen over the past couple of days, those initial sell-offs for the Canadian dollar and Mexican peso haven't been sustained.

And we've seen dollar-max and dollar-CAD fall back towards levels that were in place prior to Trump's threat at the start of this week. So with that price action, it's kind of reflecting optimism amongst market participants that Trump is not likely to follow through with those threats to impose those higher tariffs on Canada and Mexico. Obviously, if he was to do 25% tariffs on all goods from Canada and Mexico, two of the U.S.'s major trading partners, that would be very disruptive, not just for Mexico and Canada's economy, but also the U.S. economy, which is one reason I think market participants are very skeptical whether he'll actually put those tariffs in place.

And then obviously as well, we did hear very quickly from Trump just a couple of days later that he'd had an excellent call with Mexican President Scheinbaum, who he says has declared that she will put a stop to the illegal immigration across the southern border. So he already seems to be trying to claim a win, claiming that his kind of tariff threats have worked already as a negotiating tactic to force significant change at the borders for the U.S. to address the concerns over immigration and illegal drugs coming into the U.S. So certainly the sound from Trump doesn't look at this stage like he's going to put those higher tariffs in place on Mexico and Canada at the start of next year, although he hasn't completely indicated that he won't raise tariffs yet.

I think he probably will still watch over the next couple of months to see whether Canada and Mexico do make any significant changes to their border controls. So there's still that kind of lingering uncertainty that those higher tariffs could be implemented even if they're potentially watered down. So for that reason, we would still expect higher volatility to continue for the Mexican peso and the Canadian dollar as we head into early next year.

But in terms of the week ahead, in terms of the dollar, like you say, at the moment it is correcting lower. There is a risk next week that the correction lower for the dollar could prove deeper than we're expecting. I think for that to happen, though, we'd need to see a disappointing payrolls report at the end of next week.

We're expecting, like the rest of the market, the payrolls report to show a strong rebound in employment growth in November after we had the negative impact from strikes and hurricanes in October. Obviously, if we don't get that strong rebound in employment in next week's payrolls report, that could then force the U.S. rate market to more fully price in at the 25 basis point cut from the Fed in December. So I think that is certainly one kind of clear risk that could trigger a deeper dollar sell-off next week.

But yeah, it's still our kind of base case view that we see this is just a kind of temporary setback for the dollar. The Japanese yen has been the top performing trading currency this week. What has been driving the stronger Japanese yen?

Yeah, like I think it's still kind of a similar story to other currencies where we've seen the dollar correct lower across the board. That's obviously helped to bring down dollar yen while at the same time U.S. yields as well have dropped back. We look at, say, the 10-year treasury yield after initially moving higher after the U.S. election results and the Trump win and red sweep scenario.

The 10-year treasury yield has now fully reversed that move higher since the U.S. election and is now back towards support from the 200-day moving average. So I think that kind of loss of upward momentum for the dollar and U.S. yields, that is helping to bring down dollar yen. But at the same time, there's also a domestic story there as well from Japan.

We've seen certainly building speculation in recent weeks that the BOJ could act to raise rates before the end of this year. To us, that is looking more likely now. As we've heard from BOJ Governor Ueda recently, he's going to be watching closely the incoming economic data from Japan to gain further information on the performance of Japan's economy.

And as we've seen recently, the latest activity data such as personal consumption growth and some of the inflation data as well from Japan has been moving in line with the BOJ's expectations, showing improvement, a lot of positive kind of feedback loops in place between higher wage growth and strengthening economy and inflation in Japan, which, as the BOJ have said on a number of occasions now really since the middle of the year, is that as long as the economy moves in line with expectations, that will provide justification for them to keep hiking rates. So we feel that certainly it's now likely we think the BOJ will pull the trigger and hike rates again in December. So we've brought forward our forecast for the next BOJ rate hike from January into December.

So with the BOJ looking like they're going to hike again in December, that should help, as we're already seeing, should help the yen to continue to trade on a stronger footing as we head into year end. Thank you very much, Steve. Thank you.

Thank you for listening to this MUFG Global Markets podcast. Rate, review and subscribe and contact your MUFG sales rep for more information. Come back next week for more insights from the Global Markets Research Team.