Higher US Rates Support USD/JPY as Geopolitical Risks Soften

The Dollar/Yen is edging higher on Wednesday, boosted by increasing demand for riskier assets and some liquidation of Japanese Yen safe-haven positions. Firm U.S. Treasury yields are also helping to widen the spread between U.S. Government bond yields and Japanese Government bond yields, making the dollar a more attractive asset.

At 08:21 GMT, the USD/JPY is trading 115.683, up 0.0075 or +0.06%. On Tuesday, the Invesco CurrencyShares Japanese Yen Trust ETF (FXY) settled at $81.11, up $0.04 or +0.05%.

Bullish Interest Rate Differential

In a nutshell, the U.S. Dollar is a more attractive currency than the Japanese Yen because the Federal Reserve is hawkish and the Bank of Japan is dovish. Taking this stance does carry some risks, however, especially when volatile market conditions make the Yen a highly desired safe-haven asset. That’s the trade-off that long-term investors have to deal with.

Overtime, however, money seeks the highest return and when rates are rising in the U.S. faster than rates in Japan then money is going to flow into the dollar and the long-term investors will make adjustments to the risk if and when necessary.

Market Pricing in Fed Rate Hike While BOJ Makes Move to Stem Higher Rates

The U.S. Federal Reserve is expected to kick off its tightening cycle in March with a 25-basis-point interest rate rise, a Reuters poll of economists found, but a growing minority say it will opt for a more aggressive half-point move to tamp down inflation.

Rates were also forecast to rise each quarter this year to reach 1.25-1.50% by end-December, roughly where they were at the start of the pandemic two years ago.

Meanwhile, the Bank of Japan (BOJ) said last week it would buy an unlimited amount of 10-year government bonds at 0.25%, underscoring its resolve to prevent rising global yields from pushing up domestic borrowing costs too much.

Translation: The Fed is hawkish. The BOJ is dovish. Advantage goes to the U.S. Dollar.

Ukraine-Russia Situation the Wildcard

Trading 101 shows the U.S. Dollar is more attractive than the Japanese Yen. This assessment is also being reflected in the charts where the USD/JPY is trading near multi-year highs.

However, recently we’ve seen some setbacks in the Dollar/Yen Forex pair due to concerns Russia will invade Ukraine. Risky assets like stocks have sold-off on the news with investors moving money into traditional safe-haven investments like U.S. Treasurys and the Japanese Yen.

But on Tuesday, the Russian Defense Ministry said it had begun returning some troops to their bases. The announcement raised hopes of de-escalating geopolitical tensions near the Ukrainian border after days of warnings of an imminent Russian invasion.

Short-Term Outlook

A de-escalation of geopolitical tensions in Eastern Europe combined with rising U.S. interest rates will be bullish for the USD/JPY.

While a war between Russia and Ukraine, combined with a steep plunge in riskier assets will put short-term pressure on the Dollar/Yen. This move is likely to last until investors can hedge away the risks. The longer-term risk is that the conflict escalates so much that it impacts the Fed’s decision to raise rates, but that’s a long-shot.