Yen Plummets as Fed-BOJ Divergence Favors Dollar

The Dollar/Yen jumped to a five-year high last week as investors bet the U.S. economy is best suited to recover from the worldwide surge in inflation than other major economies especially Japan.

Furthermore, the interest rate differential continued to support the U.S. Dollar with the hawkish U.S. Federal Reserve set to raise interest rates after it March 15-16 policy meeting, while the Bank of Japan (BOJ) is determined to keep their benchmark rates at historically low levels.

Last week, the USD/JPY settled at 117.288, up 2.428 or +2.11% and the Invesco CurrencyShares Japanese Yen Trust ETF (FXY) finished the week at $80.00, down $1.68 or -2.06%.

One major clue that the world views the U.S. Dollar as the most attractive currency at this time is that it is going up against the Japanese Yen at a risk-averse time.

Hawkish Fed Drives Dollar Higher, Dovish BOJ Weighs on Yen

The U.S. Dollar was supported last week by expectations that the Federal Reserve will start raising interest rates at the end of its March 15-16 policy meeting, with inflation running hot.

While the U.S. central bank is all but certain to hike rates from the COVID-19 pandemic low in March 2020, the Bank of Japan, which also holds a policy meeting this week, is set to remain an outlier.

High US Inflation Cements Fed Rate Hike Expectations

The Dollar/Yen soared last week as inflation hit a four-decade high, cementing expectations that the U.S. Federal Reserve would hike key interest rates at the conclusion of next week’s monetary policy meeting to prevent the economy from overheating.

U.S. consumer prices surged in February, forcing Americans to dig deeper to pay for rent, food and gasoline, and inflation is poised to accelerate even further as Russia’s war against Ukraine drives up the costs of crude oil and other commodities.

The broad rise in prices reported by the Labor Department on Thursday led to the largest annual increase in inflation in 40 years. Inflation was already haunting the economy before Russia’s invasion of Ukraine on February 24, and could further erode President Joe Biden’s popularity.

The Federal Reserve is expected to start raising interest rates on Wednesday. With inflation nearly four times the U.S. central bank’s 2% target, economists are expecting as many as seven rate hikes this year.

Reuters:  BOJ has Little Room to Move as Ukraine Clouds Recovery, Prices Soar

The crisis in Ukraine is giving the Bank of Japan a headache not facing other major central banks, forcing it to maintain a more dovish stance on monetary policy despite rising inflationary pressures and a dearth of tools to combat another economic downturn, according to Reuters.

Unlike other advanced economies, Japan is still shackled by COVID-19 curbs that are delaying an economic recovery from the pandemic, with growth seen stalling this quarter.

Weekly Forecast

The BOJ’s dovish stance makes it an outlier as the Federal Reserve and other major central banks eye raising interest rates to combat quickening inflation.

The BOJ doesn’t have any effective tools left to prop up growth and must swim against the tide of global central banks dialing back crisis-mode stimulus means.

This likely means the recent spike in oil and grain prices in the wake of Russia’s invasion of Ukraine will deal a major blow to resource-poor Japan, while a projected slowdown in global growth threatens to cripple its export-reliant economy.

BOJ policymakers, unlike their central bank counterparts, will be focusing on ways to increase economic growth while the rest of the world concentrates on driving down inflation.