The following is a comprehensive rewritten version of the original article “USD/JPY – US-Japan Yield Spread Breakdown Signals Further Yen Strength Ahead in the Near Term” by Kelvin Wong, initially published on MarketPulse. This version maintains the core insights while providing additional depth and clarity. All credits go to Kelvin Wong and MarketPulse for the original analysis.
Title: Declining US-Japan Yield Spread Continues to Support Yen Strength Against the Dollar
Summary
The Japanese yen has continued to gain momentum against the US dollar, primarily driven by narrowing yield spreads between US Treasuries and Japanese government bonds. This trend marks a significant shift in the long-standing drivers of USD/JPY, where interest rate differentials have typically dictated direction. The recent breakdown in the 10-year US-Japan yield spread points toward more potential strength for the yen in the near term, despite divergent monetary policy paths between the Federal Reserve and the Bank of Japan (BoJ).
Key Highlights
– The USD/JPY currency pair has experienced downside pressure due to the narrowing yield differential between US and Japanese bonds.
– Technically, the US-Japan 10-year government yield spread has breached key support levels, suggesting waning bullish momentum for USD/JPY and the potential for a deeper retracement.
– Several factors continue to contribute to this shift, including market speculation of a more dovish Federal Reserve, rising expectations of future policy normalization by the BoJ, and a broader reassessment of the US dollar’s strength.
Background: Yield Differentials Drive USD/JPY
For years, the USD/JPY exchange rate has largely mirrored movements in the yield spread between US and Japanese government bond yields, particularly at the 10-year tenor. A wider spread historically supports a stronger dollar against the yen because higher US yields attract more foreign capital.
However, mounting signs of a reversal in this dynamic have emerged as global factors weigh on both economies. While Japan’s ultra-loose monetary policy and low rates have long encouraged carry trade activity, a reduction in the US-Japan yield differential may mark a turning point for potential capital flows and currency momentum.
Breakdown in the 10-Year Yield Spread
– As of the most recent data, the US-Japan 10-year yield spread has fallen to its lowest level in months, breaking beneath the critical 3.70% support zone. This support had previously held since early 2024.
– Technical analysis suggests a decisive break of this zone opens the way to a potential further decline toward 3.40%, pointing to persistent downside pressure on the USD/JPY pair.
– The spread’s slide reflects changing expectations regarding monetary policy, inflation trajectories, and growth forecasts between the two economies.
Key Drivers of Lower Yield Spread
Several interconnected macroeconomic and policy factors have contributed to the narrowing of the yield differential, each reinforcing the yen’s recent strength.
1. US Treasury Yields Slide Due to Softer Fed Expectations
– Recent US economic data has shown signs of moderation in growth, with downward revisions to previous GDP figures and persistent signs of labor market softening.
– Inflation, while still elevated compared to historical norms, appears to be moderating. The slowing in price pressures has led markets to increasingly expect the Federal Reserve to hold off on further rate hikes and even begin cutting rates by late 2024.
– Growing demand for safe-haven assets amid global geopolitical volatility and slowing global growth has also kept US Treasury yields in check.
2. BoJ Shifts Toward Policy Normalization
– Even though the Bank of Japan has not yet fully exited its ultra-dovish monetary stance, its forward guidance and recent moves suggest incremental steps toward normalization.
– In March 2024, the BoJ ended its negative interest rate regime. Although the policy rate remains near zero, this marked a historic departure from its decade-long quantitative easing program.
– Japanese CPI has remained firm, primarily driven by imported inflation and domestic wage growth. This supports the argument for an eventual further policy tightening or continued tapering
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