Japanese Yen: Rate spread outlook favors JPY against US Dollar – BBH

Brown Brothers Harriman’s (BBH) Elias Haddad notes that JPY is underperforming as firmer Oil prices support USD/JPY, while the Bank of Japan's (BoJ) latest meeting minutes did little to shift rate expectations. However, Haddad highlights that US-Japan rate differentials could narrow, with BoJ risks skewed hawkish and Federal Reserve (Fed) risks skewed dovish, implying a potential downside bias for USD/JPY over the coming months.

BoJ risks skewed to hawkish repricing

"JPY is underperforming all G10 FX and USD/JPY has retraced roughly 40% of its intervention-driven drop since July 30 as crude oil prices firmed."

"The Bank of Japan (BoJ) Summary of Opinions from the July 30-31 board meeting did not move the needle on rate hike expectations. The swaps curve continues to price 64% odds of a BoJ hike to 1.25% at the next September 18 meeting."

"In July, the BoJ voted 8-1 to keep the policy rate at 1.00% while sticking to its hawkish bias. Takata Hajime supported a 25bps hike. The Summary of Opinions showed that a couple of members argued for the BoJ to focus more on containing upside price risks."

"One member noted it was “necessary for the Bank to accelerate the pace of adjustment to the degree of monetary accommodation.” Another member highlighted “it is necessary for the Bank to raise the policy interest rate, which is below the lower bound of the broadly estimated range.”"

"We see room for US-Japan interest rate differentials to narrow further in favor of a lower USD/JPY. Risks are skewed towards a hawkish BoJ repricing and a dovish Fed repricing."

"The BoJ’s policy rate is near the lower end of its neutral range estimate (1.10%-2.50%) while Japan’s economy is operating above potential. In contrast, Fed policy is restrictive (assuming a neutral rate of 3.00%) and the economy is operating around potential. "