Yen-Dollar Carry Trade Shakes Ahead Of Powell's Speech As BoJ's Ueda Hints At Continued Rate Hikes

The dollar-yen exchange rate experienced hours of turbulence after the Bank of Japan delivered hawkish remarks overnight, just ahead of Fed Chair Jerome Powell‘s highly anticipated speech at Jackson Hole, set for 10:00 a.m. ET on Friday.

During a parliamentary hearing on Friday, BoJ Governor Kazuo Ueda reiterated his commitment to keep raising interest rates if inflation continues to align with the country’s 2% target, indicating that recent market volatility would not deter the bank’s long-term strategy for rate hikes.

However, Ueda warned that market jitters could influence the BoJ’s inflation forecasts, indicating that fluctuations in the yen and stock prices will be pivotal in determining the timing of the next rate hike.

“Markets at home and abroad remain unstable, so we will be highly vigilant to market developments for the time being,” Ueda stated.

This seems more in line the previous BoJ’s reassurances when earlier this month Deputy Governor Shinichi Uchida had vowed not to raise interest rates if market volatility persisted.

The yen, tracked by the Invesco CurrencyShares Japanese Yen Trust FXY, gained approximately 0.8% between 8:00 p.m. ET on Thursday and 2:50 a.m. ET on Friday, before slightly paring back those gains.

On Thursday, Japan’s latest inflation report showed that consumer prices rose by 2.8% year-over-year in July 2024, unchanged for the third straight month and holding at their highest level since February.

A Look At The Markets, But Also At The Economy

Although Ueda stated that the BoJ is monitoring market developments, he also reiterated that if the economy shows clear evidence that prices are moving toward the target, there is no change in the central bank’s basic stance on normalizing its accommodative monetary policy.

This means that the BoJ remains committed to gradually raising borrowing costs from their current ultra-low levels.

“Japan’s short-term rates are very low. If the economy is in good shape, they will move up to levels deemed neutral,” Ueda commented, adding that there is still “very high uncertainty on where rates will eventually rise to.”

BoJ, Fed On Different Policy Paths

On July 31, the BoJ hiked its key short-term interest rate by 15 basis points to 0.25%, and opted to halve its bond-buying program to JPY 3 trillion from next year.

This decision, along with unexpectedly weak U.S. economic data, triggered an unwinding of the yen-dollar carry trade. Traders who had been betting on interest-rate differentials between the Fed and the BoJ were hit hard by the rate reversal and subsequent margin calls.

The next BoJ meeting is scheduled for Sept. 20, just two days after the Federal Open Market Committee (FOMC) meeting. The U.S. central bank is widely expected to lower interest rates, with market-implied probabilities favoring a 25-basis-point cut. If the BoJ raises interest rates, it could deliver another blow to the dollar-yen pair, further challenging the resilience of the carry trade.

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