USD/JPY Forecast 2023 – BOJ’s Next Move Will Unwind Ultra-Dovish Policy

The Dollar/Yen is poised to move lower in 2023 as the U.S. Federal Reserve moves closer to slowing the pace of its aggressive rate hikes and the Bank of Japan (BOJ) readies for a shift in policy away from its ultra-dovish campaign.

Although we expect the USD/JPY to fall from current levels (133.714 as of Dec. 29), its downside potential isn’t clear due to the lack of clarity from the Federal Reserve at this time plus the timing of a widely expected recession.

What we are fairly certain about is that the huge divergence in monetary policy between the Federal Reserve and the Bank of Japan is going to tighten. Another way to look at it is, we see the extremely wide interest rate differential between U.S. Government bond yields and Japanese Government bond yields tightening enough to weaken the USD/JPY.

The Bull Market of 2022

The USD/JPY began moving higher the first week of 2021 when investors started to price in the end of the pandemic and the Federal Reserve’s dovish policy. After drifting higher until March 2022, the Forex pair took off to the upside following a rate hike by the Federal Reserve.

The risk of the Japanese Yen weakening further against the U.S. Dollar the rest of 2022 continued to grow throughout the spring and summer as the BOJ remained the lone major central bank clinging to easy policy.

The USD/JPY rally began to run away as the BOJ stuck to stimulus and even ramped up its bond buying to defend its yield cap even as the Fed, already on an aggressive campaign of half-point rate rises, began to lift rates at a supersized 75 basis points pace.

The resulting Yen weakness eventually became a source of contention for policymakers. The weakness in the Yen hurt household budgets by driving up living costs that were already rising due to global inflation. Furthermore, it offset the boost a cheaper currency gave to exporters.

The tumble in the Japanese Yen was so severe that it led the government and the central bank to issue a rare joint statement in June.

Although publically, Japanese officials were saying they were comfortable with the fall in the Yen since it was due to the divergence in monetary policy, they warned about excessive volatility. Privately, they were worried about its impact on the economy.

BOJ Intervenes

The situation became a real problem in early September, when the USD/JPY hit 144.991, a level not seen since 1998. This move prompted the BOJ to intervene on September 22. The Dollar/Yen retreated initially, but quickly recovered enough to drive the Forex pair to 151.945 on October 21. This time, the BOJ had had enough and hit the market with its biggest intervention in history.

The buyback of the Japanese Yen combined with talk of a pivot in Fed policy in the near future helped drive the USD/JPY to 130.566 on December 20.

Bank of Japan to Unwind Loose Policy in 2023

With the BOJ intervention taking hold and the Federal Reserve moving closer to its terminal rate, the focus in 2023 will be the BOJ’s next policy move, which is expected to be the unwinding, not the strengthening of its massive easing campaign.

The timing of such move is yet to be determined, however. In late November, 90% of economists polled by Reuters said the change in policy was unlikely before the latter half of 2023. However, some contend that the movement away from the prolonged loose policy will correlate with the end of the 10-year tenure of BOJ Governor Haruhiko Kuroda at the end of April.

The outlook for when the BOJ changes policy moved closer to the end of April on December 20 when a surprise policy tweak by the Bank of Japan lifted the Yen by 4% against the U.S. Dollar.

At that time, the BOJ decided to change its “yield curve control” policy by letting 10-year yields move 50 basis points either side of its 0% target, wider than the previous 25-basis point band.

BOJ Policymakers See Fading Deflation Risks

In another sign that BOJ rate hikes are a possibility in 2023, at their last policy meeting in early December, policymakers discussed growing prospects that higher wages could finally eradicate the risk of a return of deflation.

Their increasing attention to mounting inflationary pressures should keep alive market expectations the BOJ will phase out dovish Governor Haruhiko Kuroda’s massive stimulus when he steps down in April 2023.

BOJ Will Change Policy after Kuroda Departs

In our opinion, the USD/JPY will trend lower throughout the year after Governor Kuroda retires. This will allow policymakers to withdraw stimulus measures. However, signs of an end to Japan’s deflationary period will allow policymakers to lift rates at some point in 2023. This should alleviate some of the selling pressure on the Japanese Yen, fueling a weaker USD/JPY throughout the year.

The size of a potential sell-off in the USD/JPY will be contingent upon whether the Federal Reserve makes a pivot toward slowing its rate hikes or if there in a global recession.

If the Fed pivots and the BOJ raises rates then we could see the USD/JPY test 120.00 to 115.00. If there is a recession then the U.S. Dollar could strengthen if investors decide to use it as a safe-haven.

The key takeaway, however, is that the BOJ will change policy in 2023 and that should help support the Japanese Yen.