USD/JPY Set for Further Decline as Bank of Japan Signals Further Rate Hikes

The recent rate hike by the Bank of Japan (BOJ) has induced a sharp decline in the USD/JPY. This article provides a fundamental and technical overview of USD/JPY to determine the next direction for the pair and identify investment opportunities. It is found that further rate hikes are expected, and technical price patterns are negative, indicating further weakness.

Impact of Bank of Japan’s Rate Hike on USD/JPY

The recent rate hike by the Bank of Japan (BOJ) to 0.25% has had a significant impact on the USD/JPY currency pair, causing the US Dollar to fall sharply against the Japanese Yen. This reaction was largely driven by the unwinding of carry trade positions, where investors borrow in a low-interest-rate currency like the Yen to invest in higher-yielding assets elsewhere. As the BOJ raised rates, these trades became less attractive, prompting a sell-off in financial markets and a surge in the Yen’s value. These expectations of rate hikes were discussed in a previous article, and the market has moved accordingly.

However, this has not yet been finalized, and further rate hikes by the BOJ are expected, with the next policy meeting scheduled for October. This expectation is supported by recent economic data, including a 2.4% annual increase in the Consumer Price Index (CPI) excluding fresh food in Japan’s capital, which exceeded the 2.2% consensus forecast. The sustained growth in CPI over the past four months suggests growing inflationary pressures in Japan, potentially leading the BOJ to consider additional tightening measures. If the BOJ does move to raise rates again, it could further strengthen the Yen against the Dollar, as higher interest rates would make Yen-denominated assets more attractive to investors.

Additionally, wage growth in Japan is another factor that could influence the BOJ’s decision to move towards monetary policy further. Data from the Japanese Trade Union Confederation indicates that average pay has risen by 5.2% this year, the highest increase in over three decades. This surge in wages suggests that inflationary pressures may continue to build, providing the BOJ with further justification to raise rates to prevent the economy from overheating. If the BOJ opts for another rate hike, it could exacerbate the USD/JPY pair’s downward trend, as the Dollar could weaken further in response to a stronger Yen and higher Japanese interest rates.

Despite these signals, some investors remain skeptical about the likelihood of further rate hikes in the near term. Interest rate futures currently suggest only a 9% chance of additional tightening at the BOJ’s upcoming October meeting. This cautious stance reflects concerns about the potential for financial instability following another rate hike, given the market turmoil that accompanied the previous adjustment. Nonetheless, the possibility of further BOJ action cannot be entirely ruled out, particularly if inflation data continues to exceed expectations or if wage growth remains robust.

Meanwhile, inflation in the United States has been relatively moderate. For the 12 months ending in July, the Core Personal Consumption Expenditures (PCE) inflation rate rose slightly to 2.6%, while the Trimmed Mean PCE inflation rate decreased to 2.7%, as illustrated in the chart below. Therefore, the Fed is considering interest rate cuts in the September meeting.

Bearish Trends Suggest Lower Levels Ahead

It was discussed in the previous article, where it was noted that USD/JPY began a strong downside move following the BOJ rate hike, as per expectations. The likelihood of a significant drop in USD/JPY was due to the strong long-term resistance levels where the pair was overbought and needed to correct lower. Additionally, the strong JPY and weaker USD economic environment further supported the case for a significant correction in USD/JPY.

The chart shows that after the strong decline, the monthly candles for July and August suggest that September could also be a weaker month. The beginning of September has indeed been weaker, indicating that this pair may drift lower further. It is interesting to note that the RSI is correcting from the overbought region and is currently at the mid-level, which could provide support. This support will be further evaluated during the Fed meeting in September, where interest rate cuts are expected, potentially inducing significant volatility in USD/JPY.

Strong resistance in USD/JPY is also observed in the weekly chart below, which shows that the price is trading within a channel. This resistance level validates the current resistance on the monthly chart. The upper resistance line of this channel creates a divergence with the RSI, as seen in the chart below. This divergence suggests that USD/JPY is likely to drift lower. The two red lines on this chart also form a rising wedge pattern, which has successfully broken to the downside, indicating that the pair is likely to continue downward toward the $136 level. In case of a strong rebound, the $151-$152 level is expected to act as resistance, protecting against the rebound and continuing the drop toward the $136 level.

Market Risks

The recent developments in Japan’s monetary policy pose several market risks for the USD/JPY currency pair. A key risk is the potential for further appreciation of the Yen if the Bank of Japan continues to raise interest rates. The rapid changes in exchange rates could impact corporate earnings and trade balances, especially for Japanese exporters, who may find their products becoming less competitive globally due to a stronger Yen.

Another significant risk involves the broader implications of divergent monetary policies between Japan and the United States. While the BOJ seems poised for further tightening due to rising inflation and wage growth, the Federal Reserve is considering interest rate cuts in response to moderate inflation in the U.S. This divergence could lead to further depreciation of the U.S. Dollar against the Yen, exacerbating current trends and increasing market uncertainty. Moreover, if the market underestimates the pace or scale of these policy changes, there could be abrupt corrections in currency values, triggering stop-losses and amplifying market movements. Such volatility could affect bond and equity markets, creating a ripple effect across global financial systems.

Conclusion

In conclusion, the Bank of Japan’s recent rate hike has markedly influenced the USD/JPY currency pair, driving a sharp decline in the U.S. Dollar against the Yen due to the unwinding of carry trades and growing expectations of further tightening by the BOJ. As Japan’s economic indicators suggest rising inflation and wage growth, the potential for additional rate increases could strengthen the Yen further. At the same time, a cautious stance from the Federal Reserve could weaken the Dollar. This evolving economic environment has created a volatile backdrop for USD/JPY, with significant market movements expected depending on upcoming policy decisions from both central banks. Investors may consider selling USD/JPY on any rallies toward the resistance level of $151-$152, targeting $136.