Stronger Economy, Rising Rates Favor Dollar Over Yen

The Dollar/Yen rose sharply last week as traders priced in a series of aggressive rate hikes by the Federal Reserve in 2022. Meanwhile, Bank of Japan policymakers continued to stress the need to maintain ultra-loose monetary policy to support a fragile economy.

Essentially two factors supported the Dollar/Yen. Firstly, the U.S. economy is performing much better than the Japanese economy. Secondly, with the Fed set to raise rates, the interest rate differential between U.S. Government bonds and Japanese Government bonds, widened, making the U.S. Dollar a more attractive asset.

Last week, the USD/JPY settled at 115.240, up 1.541 or 1.36%. The Invesco CurrencyShares Japanese Yen Trust ETF (FXY) finished the week at $81.37, down $1.20 or -1.45%.

Fed Points to Interest Rate Hike Coming in March

Facing both turbulent financial markets and raging inflation, the Federal Reserve last week indicated it could soon raise interest rates for the first time in more than three years as part of a broader tightening of historically easy monetary policy.

In a move that came as little surprise, the Fed’s policymaking group said a quarter-percentage point increase to its benchmark short-term borrowing rate is likely forthcoming. It would be the first rise since December 2018.

The post-meeting statement from the Federal Open Market Committee (FOMC) did not provide a specific time for when the increase will come, though indications are that it could happen as soon as the March meeting. The statement was adopted without dissent.

BOJ Debated Chance of Inflation Pick-Up Towards 2% as Price Hikes Broaden

Some Bank of Japan policymakers saw consumer inflation briefly accelerating towards their 2% target as price pressures build up on changing corporate price-setting behavior, a summary of opinions at the bank’s January meeting showed last week.

Many board members, however, stressed the need to maintain ultra-loose monetary policy to support a fragile economy facing fresh risks from a spike in Omicron coronavirus cases, the summary showed.

At its January meeting, the BOJ raised its price forecasts but said it was in no rush to change its ultra-loose policy with inflation still distant from its target.

Short-Term Outlook

Although the interest rate differential supports the U.S. Dollar, there is still the possibility that safe-haven demand for the Japanese Yen due to stock market volatility slows the rally or reverses the bullish chart pattern. The wildcard is the Ukraine-Russia stand-off. If a war begins, investors may move money into the Yen for protection.