Can the Japanese Yen rely on its safe-haven appeal in

Can the Japanese Yen rely on its safe-haven appeal to gain dominance over the US Dollar in Q2?

Japan’s recent inflation print has reignited hopes that newly elected Governor Ueda will pivot from the current ultra-loose monetary policy. With the BoJ (Bank of Japan) implementing monetary easing for 10 years under former governor Haruhiko Kuroda, pressure is mounting for the central bank to clarify its future policy stance to manage expectations.

While the BoJ is expected to maintain the current status quo throughout Q2, the focus remains on how the Federal Reserve will react to further turmoil in the banking sector.

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BOJ – Probability distribution for 2023

After announcing a series of aggressive rate hikes throughout 2022, the Federal Reserve continued to raise rates, driving the terminal rate to 5%. This means that the Fed had increased interest rates by 4.75% over a one-year period. While higher rates had been a key driver of USD strength, they also represented a substantial increase in borrowing costs, making it more difficult to finance debt.

Shortly after the collapse of Silicon Valley Bank (SVB) and Signature Bank, concerns over the financial health of Credit Suisse and First Republic Bank heightened contagion fears. To allay these fears, the Federal Reserve, the US Treasury, and FDIC confirmed that clients of the failed banks would have access to their deposits. Two days after US authorities announced these emergency measures to restore confidence in the banking sector, the largest shareholder of Credit Suisse made it clear that they would not provide any financial assistance for the cash-strapped bank. Due to regulatory constraints, the Saudi National Bank can not increase its holding of the bank’s shares above the 10% threshold.

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With a potential banking crisis brewing in the world’s largest economy (the United States), fear of contagion sent jitters through markets. It also raised the probability of US recession occurring by the start of next year to 60%.

Source: Refinitiv DataStream

In response to the recent turmoil, Fed expectations fell sharply, boosting the safe-haven Yen. With US Treasury yields continuing to take the strain, a continuation of this theme in Q2 could drive USD/JPY lower.

With forecasts currently predicting that the Fed will cut rates by 50 basis points before the end of the year, the BoJ (Bank of Japan) continues to stick to its ultra-loose monetary policy.

Although the interest rate differential has weighed heavily on JPY, the repricing of lower rate expectations and a stable banking system could see the Yen appreciate against its Dollar counterpart.

US Probability distribution of rate hikes for the remainder of 2023

Source: Refinitiv

USD/JPY Technical Analysis

After three months of consecutive losses, USD/JPY fell to the mid-point of the 2021 – 2022 move, before heading higher. In February, the Federal Reserve adopted a more hawkish tone for the March 2023 FOMC, sending yields and the greenback higher. Although bulls temporarily succeeded in pushing the major currency pair back above the 200-day MA (137.450), a shift in the fundamental backdrop and the collapse of US banks has erased most of February’s gains.

With USD/JPY currently trading at a discount of 10% over the past six-months, both bulls and bears may have to clear some big technical levels before determining a clear directional bias.

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How to Trade USD/JPY

USD/JPY Weekly Chart

Source: TradingView

On the daily chart below, price action is trading within the confines of a falling wedge. After a brief period of consolidation around the 50-day MA (132.500), an increase in bearish momentum initiated a move toward support, current holding at the key psychological level of 130.00.

Over the next three months, the January low could provide an additional layer of support around 127.233 If prices break below the lower-bound of the falling wedge, bears could hold onto the downtrend. The next target of support rests at the 61.8% Fibonacci of the 2021 – 2022 move at 121.445 paving the way for a move toward 115.00.