Japanese Yen Rallies On Bank Of Japan's Rate Hike Pledge, US Manufacturing Activity Contraction

The Japanese yen sent shockwaves through the markets at the start of September, triggering alarms for traders already on edge in what is shaping up to be a highly volatile month.

The yen, as tracked by the Invesco CurrencyShares Japanese Yen Trust FXY, appreciated over 0.9% by 11:30 a.m. ET, fueled by hawkish remarks overnight from Bank of Japan (BoJ) Governor Kazuo Ueda and disappointing U.S. manufacturing data.

In a parliamentary speech Tuesday, Ueda reaffirmed that the central bank would continue to raise interest rates if the economy and inflation evolve as expected. Ueda reiterated that the economic environment remains accommodative, despite the July rate hike, as real interest rates continue to be significantly negative.

“Traders hoping for a dovish pivot didn't get it,” said analyst Michael Gayed.

According to Gayed, with the Federal Reserve likely to cut rates by 75-100 basis points by the end of the year and the BoJ potentially hiking at least once more during the same period, the interest rate gap could narrow significantly.

Gayed also added, “This could ultimately trigger the next rally for the yen and potentially drive stock prices higher in the longer term.”

US Manufacturing Sector Contracts, Analysts See Mixed Yen Performance

In August, the U.S. manufacturing sector remained in a contractionary phase for the fifth consecutive month. However, the pace of decline eased slightly compared to July, according to the Institute for Supply Management (ISM).

“This should be positive news for equities and keeps the door open for more rate cuts,” said Gina Bolvin, president of Bolvin Wealth Management Group.

Jeffrey Roach, chief economist at LPL Financial, commented, “Manufacturing employment contracted for the third consecutive month as activity in the sector slowed. While manufacturing now represents a smaller portion of the macroeconomy than in previous cycles, investors should still prepare for a broader slowdown throughout the remainder of the year.”

Treasury yields fell sharply following Tuesday’s data release. The yield on the 10-year bond fell 7 basis points to 3.85%.

Bloomberg reported that Arif Husain, head of fixed income at T. Rowe Price, expects further volatility as the yen-dollar carry trade unwinds, predicting more episodes similar to the one seen in early August.

Husain believes the yen is on an appreciating trend due to Japan’s ongoing structural transformation, driven by demographic shifts. He also highlighted that persistent inflation is likely to accelerate corporate reforms and influence household asset allocation.

“The ideal macro environment for yen appreciation usually occurs when U.S. real rates and equities decline together, typically during a U.S. recession,” said Kamakshya Trivedi, an economist at Goldman Sachs.

Contrarily, Daysuke Takato, an economist at Bank of America, argued, “The yen’s weakness has been driven by two main factors: the interest rate differentials between Japan and the rest of the world, and structural capital outflows from Japan.

While the potential for further yen depreciation may be limited in the short term, we believe the yen will resume its downtrend by year-end, as structural outflows persist.”

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