Japanese Yen Forecast: USD/JPY Eyes 160 Amid Fiscal Policy Concerns

USD/JPY eyes 160 for the first time since the July 2024 yen carry trade unwind as political uncertainty and concerns over monetary and fiscal policy weaken the yen.

The USD/JPY pair gained momentum in the first half of the week despite rising beyond the 157 level, a previous yen intervention threat zone. Japan’s finance minister previously warned of yen intervention in the forex markets in the 157-158 range.

This week, 10-year Japanese Government Bond (JGB) yields surged to 2.178%. The weaker yen and soaring yields reflected market sentiment toward Prime Minister Sanae Takaichi’s plans for a snap election. Fading bets on a March Fed rate cut have added to USD/JPY momentum.

Below, I’ll discuss the macro backdrop, the near-term price catalysts, and technical levels traders should closely watch.

Snap Election and Fiscal Policy Concerns Sink the Yen

News outlets reported that Japan’s Prime Minister Takaichi may call for a snap election in February over the weekend, her first time facing national voters. Speculation about a snap election intensified as Takaichi’s approval rating jumped to 78.1% in January, according to a JNN public opinion survey.

Meanwhile, the Liberal Democratic Party’s approval rating remains below 30%, fueling uncertainty over how voters will side in a national election. A strong election win would enable Takaichi to push through fiscal stimulus plans, weighing on demand for the yen. Takaichi’s fiscal stimulus plans and Japan’s debt-to-GDP ratio have led to a surge in risk premiums for holding JGBs, sending yields to decade highs.

Robin Brooks, Senior Fellow at the Brookings Institution, commented:

“Japan is trapped in a very bad place and is the G10 country that’s closest to a full-blown debt crisis. Japan’s only choice is to accept higher interest rates and a debt crisis or – if it caps yields – a depreciating yen, which is nearing its 2024 lows…”

Notably, USD/JPY has surged 8.25% since Takaichi’s election win to become the LDP leader in early October. USD/JPY trends underscored market concerns about her stance on fiscal stimulus and monetary policy.

The political uncertainty supports a cautiously bullish short-term price outlook for USD/JPY. However, potential yen interventions and the prospect of Bank of Japan rate hikes affirm the bearish medium-term projection.

Crucially, the weaker yen would increase import prices, eroding households’ purchasing power. These scenarios may force the BoJ to signal further policy tightening to strengthen the yen.

US Producer Prices and Retail Sales to Drive Dollar Demand

Later on Wednesday, US retail sales and producer prices are likely to influence market bets on a March Fed rate cut.

Economists forecast retail sales to rise 3.0% year-on-year (YoY) in November, down from 3.5% in October. Weaker consumer spending would signal a softer demand-driven outlook, supporting a more dovish Fed rate path.

Meanwhile, economists expect producer prices to increase 2.7% YoY in November, mirroring October’s rise. Softer-than-expected producer prices would raise expectations of a March Fed rate cut, weighing on demand for the US Dollar. Increased bets on a March cut would support the bearish medium-term outlook for USD/JPY.

According to the CME FedWatch Tool, the probability of a March Fed rate cut fell from 48.5% on January 6 to 25.7% on January 13. Stronger-than-expected US labor market and Services PMI data cooled expectations of a March cut.

Today’s US economic data will be key for the near-term USD/JPY price outlook. Stronger US data would signal a more hawkish Fed policy stance, strengthening the US dollar, and challenging the bearish medium-term outlook.

Nevertheless, expectations of multiple BoJ rate hikes and a new Fed Chair potentially favoring lower interest rates remain key considerations. These factors reinforce the bearish medium-term outlook for USD/JPY.

Technical Outlook: Key Levels to Watch

For USD/JPY price trends, traders should consider technicals and closely monitor the fundamentals.

Viewing the daily chart, USD/JPY trades well above its 50-day and 200-day Exponential Moving Averages (EMAs), indicating bullish momentum. While technicals remain bullish, bearish fundamentals are evolving, countering the technicals.

A drop below 157 would bring the 50-day EMA and the 155 support level into play. A sustained fall below the 50-day EMA would signal a bearish near-term trend reversal, exposing the 200-day EMA. If breached, 150 would be the next key support level.

Crucially, a sustained fall below the 50-day and 200-day EMAs would reinforce the bearish medium-term price outlook.

Position and Upside Risk

In my view, expectations for BoJ rate hikes, potential warnings of yen intervention, and bets on Fed rate cuts support a negative price outlook. However, the BoJ neutral interest rate and upcoming US data will be pivotal, given the focus on US-Japan rate differentials.

A hawkish BoJ neutral interest rate level (potentially 1.5%-2.5%) would signal multiple BoJ rate hikes and a narrower US-Japan interest rate differential. A narrower-than-expected rate differential may trigger a yen carry unwind, sending USD/JPY toward 140 over the longer term.

However, upside risks to the bearish outlook include:

• Dovish BoJ chatter and a dovish neutral interest rate (potentially 1%-1.25%).
• Strong US economic data.
• Hawkish Fed chatter.

These events would send USD/JPY higher. However, the threat of yen interventions is likely to cap the upside at the 160 level, based on the latest communication.

Read the full USD/JPY forecast, including chart setups and trade ideas.

Conclusion: Politics, Neutral Rate, and US Data in the Spotlight

In summary, the USD/JPY trends will hinge on Prime Minister Takaichi’s election and policy goals, the BoJ’s neutral rate, and the Fed rate path.

While a comfortable Takaichi election win would be USD/JPY bullish, a hawkish neutral rate (1.5%-2.5%) would indicate an aggressive BoJ rate path, delivering yen strength. Additionally, dovish Fed chatter would raise expectations of narrower rate differentials, reaffirming the bearish outlook for USD/JPY.

Notably, a sharply stronger yen could trigger the unwinding of yen carry trades, which would likely send USD/JPY toward 140 over the longer 6-12 month timeline.

For more in-depth analysis, review today’s USD/JPY trading setups in our latest reports and consult the economic calendar.