Dollar Dives Vs. Yen: BoJ Governor Signals End In Sight For Negative Interest Rates

The U.S. dollar fell sharply against the Japanese yen on Thursday as foreign exchange traders interpreted comments by Bank of Japan governor Kazuo Ueda to suggest the central bank will soon end its negative interest rate policy.

The U.S. currency fell 2.6% against the yen (USD/JPY) in early trading on Thursday. The yen also gained strongly versus other rivals, climbing 2.4% against the euro and 2.7% on the U.K. pound.

Exchange traded funds that track both long and short positions on the yen were also big movers. ProShares UltraShort Yen YCS fell 3.7%, while the ProShares Ultra Yen YCL, which tracks bullish interest, surged 3.5% early trading on Thursday.

Meanwhile, the Invesco US Dollar Index Bullish Fund UUP was down 0.2% in early trading, while the Invesco US Dollar Index Bearish Fund UDN gained 0.3%.

Policy Tightening Expected From BoJ

The moves were in response to comments from Governor Ueda on the sustainability of Japan’s negative rates policy. Ueda said that monetary policy management would “become even more challenging from the year-end and heading into next year,” suggesting rates could be raised imminently.

Japan’s negative rates policy began in January 2016, setting the short-term interest rate at -0.1% and targeting the yield on the 10-year Japanese Government Bond (JGB) at 0%, with a cap at 1%. The BoJ made its first steps into unwinding the policy in November by removing the cap on the JGB, instead suggesting it now become a reference rate.

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Earlier in the week, BoJ Deputy Governor Ryozo Himino said in a speech that Japan’s aging population of savers would benefit from higher net interest income if rates were to rise.

But the pace of such rises is unlikely to move the needle on yen sentiment a great amount. After four decades of benign inflation, the BoJ is entering new territory and will likely do so very cautiously.

“We see scope for the market to be disappointed over the pace with which the BoJ is willing to withdraw policy accommodation over the next year or so,” said Jane Foley, senior FX strategist at Rabobank.

“That said, we expect the currency pair (USD/JPY) to shift lower in the second half of next year on the back of Fed rate cuts and a very gradual unwind in BoJ policy accommodation.”

Is Dollar/Yen Carry Trade Over?

As the Fed cuts rates and the BoJ starts to raise, FX markets could see a long-term driver of USD/JPY gains begin to fade as the carry trade becomes more risky.

The carry trade sees currency investors profit from interest rate differentials: forex traders borrow in low yielding currencies such as the yen, to invest in higher-yielders such as the dollar. Such has been the weight of the carry trade, the dollar has gained more than 40% against the yen in the past two years.

“We doubt USD/JPY will start correcting well in advance before the Fed's first rate cut, given the magnitude of carry,” said Shusuke Yamad, FX and rates strategist at Bank of America.

The Fed is still expected to make its first rate cut in the first half of 2024, possibly May.

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