USD/JPY stuck in a stalemate zone, fated to eventually fall

• USD/JPY is trapped in a range with neither bulls or bears willing to commit. 
• Fear of intervention prevents upside and the potential for US Dollar strength downside. 
• Most institutional investors sees USD/JPY falling eventually once rates narrow. 

USD/JPY is trading in the 151.300s on Tuesday, little changed from the previous session as it enters a stalemate zone below multi-year highs. 

The pair is trapped in a narrow consolidation as both sides of the trade suffer from paralysis. 

Bulls are paralyzed by the fear of intervention from the Japanese authorities and bears by the potential for the US Dollar (USD) to excel given the above-average performance of the US economy, as well as fading hopes of an early interest-rate cut by the Federal Reserve (Fed).

USD/JPY to weaken in the long-term

Institutional analysts are generally bearish about USD/JPY in the medium-to-long run. They mostly view interest-rate cuts by the Fed as inevitable – a question of when not whether. There is also an increasing consensus that there will be more interest-rate hikes from the Bank of Japan (BoJ). 

According to a Bloomberg survey of economists, the majority believe the BoJ will raise interest rates again in October, if not before. 

In contrast the Fed is expected to cut as soon as June, with a probability of 69.9% rates will come down in that month, according to the CME FedWatch tool. 

“We think the US-Japan yield differential is set to narrow, this, among other factors, should provide support for the JPY,” say economists at HSBC. 

The Yen is destined to rise across the board, in fact, as global inflation comes down and central bank easing gains momentum, according to analysts at MUFG. 

"When global yields do start to move lower, the stance of the BoJ will certainly reinforce the scale of yen appreciation,” they say in a recent note. 

The yen could fall to the 140.000 level once the reversal gets underway and the yield spread between the US and Japan narrows. 

“​​We still see scope for USD/JPY to drop to at least 140.00 by year-end with risks of a move to the mid-130.00’s,” adds MUFG. 

ING are not as convinced USD/JPY will go lower arguing such a move would be dependent on the US Federal Reserve cutting interest rates, something still not guaranteed.

“A recovery in JPY remains even more strictly tied to US rates breaking lower."

Yenccentric move 

Many were taken off guard by the Yen’s counter-intuitive move following the BoJ’s March meeting. For the first time since 2007 the bank decided to raise interest rates. Normally this would be expected to strengthen a currency substantially, especially after such a long delay. Yet in the case of the Yen, the opposite was true. 

Some put it down to the move being too widely telegraphed prior to the meeting, causing a “buy the rumor sell the fact” trade, whilst others suggested the Yen fell because the rate hike was a case of a “one and done”. 

Japan’s FX chief Masato Kanda put the Yen’s eccentric devaluation down to speculators playing a contrarian trade to make a quick killing. Indeed, data from the Commodity Futures Trading Commision (CFTC) shows large speculators such as hedge funds loading up their short bets on the Yen in the week of the BoJ decision. 

Eventually, the explanation that seems the most reasonable is that despite the rise in Japanese interest rates from negative 0.1% to a range between 0.0% and plus 0.1%, they remain extremely low in comparison to other countries. This means the Yen still “remains the most popular funding currency for carry trades,” according to FX strategists at ING. 

The carry trade is an operation by which traders borrow in a “funding currency” such as the Yen, to buy a currency with a higher interest rate, such as the New Zealand Dollar (5.5%) or US Dollar (5.5%).The profit lies in the difference between the cost of the  interest repayments and the interest earned at the higher rate – assuming a constant exchange rate.