JPY Monthly- May 2023

Summary

The Ueda BOJ's first move was to maintain the status quo. It appears that the BOJ is still not convinced that it will stably achieve its 2% inflation target. The USD/JPY came under upward pressure because some investors had seen the outside possibility of a policy change. We expect the USD/JPY to continue to swing back in the short term. However, we do not expect strong downside pressure on the yen because expectations for a change in monetary policy in the near future have not been extinguished. Meanwhile, the FOMC in May is expected to raise rates by 25bp and halt further hikes from there. We expect the Fed will continue to rein in expectations of rate cuts, but with the market's focus shifting to the timing of rate cuts, we continue to expect a moderate decline in the USD/JPY as a medium-term trend.

April in review

The USD/JPY opened the month at 133.34. The dollar weakened as US indicators released from the start of April, such as the ISM manufacturing index, the job openings and labor turnover survey, the ADP employment report, and the ISM non-manufacturing index, fell short of market expectations across the board. The USD/JPY fell to 130.64 on 5 April. However, the US employment statistics for March released on 7 April showed a fall in the unemployment rate along with a rise in the participation rate. The dollar rose across the board as this suggested that labor market conditions remain tight. In addition, on Monday 10 April, new BOJ Governor Kazuo Ueda's inaugural press conference was interpreted as dovish, causing the yen to weaken and the USD/JPY shot up to around 134. The pair fell back to around 132 after both the US consumer price index (CPI) announced on 12 April and the US producer price index (PPI) announced on 13 April fell short of market expectations, but the USD/JPY strengthened again after Fed Governor Christopher Waller said on 14 April that further monetary tightening was necessary and the University of Michigan survey showed a rise in inflation expectations. The USD/JPY gained further momentum and rose to 135.14 on 19 April, after the New York Fed's empire state manufacturing index for April, announced on the 17th, exceeded market expectations. However, the USD/JPY then became top heavy as the number of new jobless claims announced on 20 April reached the highest level since November 2021, and the Philadelphia Fed index missed expectations. This was followed by renewed concerns about regional US bank operations. The USD/JPY came under downside pressure as UST purchases picked up in a move to risk off, temporarily falling to around 133 on 26 April. Movement paused on the morning of 28 April as the market waited on the BOJ's monetary policy meeting, but the USD/JPY rose sharply after meeting outcome was announced around 13:00 JST. The USD/JPY had recovered to above 135 at the time of writing this report (Figure 1).

The prevailing view in April based on Governor Ueda's remarks and speculative reports was that the BOJ would hold off on making any change in monetary policy. ECB officials repeatedly took a hawkish stance during this period, and as a result the EUR/JPY rose to above 148 for the first time in about eight years. Meanwhile, the AUD was weak following the RBA's decision to suspend rate hikes, suggesting that differences in monetary policy stance are having a strong impact on the positions of major currencies (Figure 2).

FIGURE 1: USD/JPY (DAILY)

Note: As at 13:30 JST on 28 April

Source: EBS, MUFG

FIGURE 2:  MAJOR CURRENCIES' RATE OF CHANGE VS USD IN APRIL

Note: As at 13:30 JST on 28 April

Source: Bloomberg, MUFG

Foreign exchange market remains sensitive to monetary policy stances

As of the time this report was written, the USD/JPY in April had recorded a low of 130.74 and a high of 135.14, moving in a range of 4.50 yen, which is the narrowest range since February 2022. In the first half of April, the USD/JPY was exposed to upward pressure as concerns about the financial system in March receded, but even so, the sharp swing back seen in February and March did not occur. The FOMC meeting on 2-3 May is almost certain to vote on another 25bp rate hike, but the prevailing view is that the rate hike cycle will end at that point. Such changes in the situation surrounding the Fed's monetary policy are likely exerting downward pressure on the dollar. Meanwhile, the yen faced selling pressure as BOJ Governor Ueda's comments dispelled expectations that the BOJ would move to revise monetary policy soon after the new governor took office. Of course, expectations for a change in monetary policy in the near future have not completely disappeared, meaning the yen is unlikely to weaken sharply in the short term. However, with the ECB still maintaining its hawkish stance, the EUR/JPY has hit an eight-year high. This suggests that monetary policy stances in Japan and overseas remain a driver in the foreign exchange market. In other words, we would expect the market's attention to shift to the FOMC once the reaction to Governor Ueda's press conference has run its course.

Fed to finally halt rate hikes at FOMC in May

Concerns about the US financial system, which surfaced after the collapse of a medium-sized bank in March, reignited after regional banks announced their Jan-Mar financial results. Through 1 May, US authorities are reviewing the circumstances that led to the bank failures, considering proposals for revising banking regulations and supervision, and carrying out a comprehensive review of the deposit insurance system. Whether such administrative measures can win the trust of the financial markets will likely be a touchstone for alleviating concerns about the financial system. On the other hand, the recent bank failures were sparked by an outflow of deposits because deposit interest rates were lower than the federal funds rate, the UST yield, or the investment yield of MMFs benchmarked against them. This divergence in interest rate levels is ultimately due to the Fed's interest rate hikes, which is why it is becoming difficult for the Fed to continue raising interest rates while ignoring concerns about the financial system.

In addition, concerns about the financial system appear to have triggered a credit squeeze. The Fed's latest regional report (Beige Book) identified a tightening in credit conditions in each district. Downward pressure on the economy due to rapid monetary tightening combined with tighter credit conditions is gradually weighing on the real economy. Most of April's business sentiment surveys, which have something of a preliminary nature, were weak, and leading economic indicators continue to deteriorate (Figure 3). In addition, 1Q real GDP growth announced on 27 April was an annualized +1.1% QoQ, confirming a considerable slowdown, which ran counter to the assessment at the time that the US economy had not decelerated unexpectedly (Figure 4). Furthermore, regarding employment and prices, which are important factors in monetary policy decisions, the recent increase in the number of new jobless claims suggests the brakes have started to be applied on employment growth. Overall, the US economy does not seem in need of monetary tightening, at least not to the extent the Fed assumed at the time of its most recent economic outlook compiled in March. It therefore seems reasonable to assume that the Fed will end rate hikes at the FOMC meeting in May, when the federal funds rate will reach the upper limit of 5.25%, which is the terminal rate of the current rate hike cycle suggested by the dot plot.

From the perspective of dialogue with the market, the focus will likely be on the extent to which the FOMC statement and Fed Chair Jay Powell's subsequent press conference fosters a sense that the rate hike cycle is coming to an end. Messaging that could be taken to suggest that the Fed will continue hiking rates at the next meeting in June would probably add fuel to resurgent concerns about the financial system. We therefore expect the Fed to make it fairly clear that it plans to end its rate increases.

Fed unlikely to pander to markets expectations for rate cuts

However, suggesting an end to rate hikes does not necessarily mesh with the prospect of future rate cuts priced in by the market. Rather, we would still see a large gap between market expectations and the Fed's position. We currently see little need for the Fed to take a more hawkish stance, but there are not many reasons to be optimistic about price developments either. We therefore expect the Fed to stick to its current stance of not considering a rate cut by the end of the year. It would be a major surprise if Fed Chair Powell hinted at an interest rate cut in the near future, and this would probably lead to a rapid weakening of the dollar. The USD/JPY would also face considerable downside risk with Japanese investors absent during the long public holiday in Japan. We could consider this situation a tail risk, but in any event, the market will turn its attention to the timing of a rate cut if an end to rate hikes is confirmed. A rise in expectations for a rate cut normally acts to push up long-term interest rates due to the prospect of an economic recovery. However, long-term interest rates are currently considerably higher than the Fed's neutral interest rate of 2.5%. This suggests that expectations for rate cuts may not result in a clear uptrend in long-term interest rates. It would be more appropriate to expect a gradual decline. We therefore see little prospect of a rise in long-term interest rates and a stronger dollar. We do not expect the Fed to meet market expectations for rate cuts any time soon, and consequently expect the dollar to come under steady pressure despite moderate expectations for rate cuts.

We also need to closely watch the fight over raising the federal debt ceiling in the US. Treasury Secretary Janet Yellen warned on 25 April that a debt default would produce an "economic and financial catastrophe" including job losses and a surge in household payments on mortgages, auto loans, and credit cards. With the government potentially being unable to pay its bills as early as June, the Republican controlled House of Representatives passed a bill to raise the debt limit on 26 April. However, the bill contains a raft of conditions for raising the debt ceiling that stand no hope of making it through the Democratic controlled Senate. We expect the approach of "X-Day" (the date when the government will no longer be able to meet its financial obligations on time) to weigh on market sentiment and dollar weakness to become more pronounced.

FIGURE 3: YOY CHANGE IN LEADING INDICATORS AND MOM CHANGE IN JOB NUMBERS

Source: US Bureau of Labor Statistics, Conference Board, MUFG

FIGURE 4: REAL GDP (ANNUALIZED QOQ)

Source: US Department of Commerce, MUFG

The new BOJ regime leaves monetary policy on hold for now

The BOJ voted to leave policy unchanged at Kazuo Ueda's first board meeting as governor. It dropped the forward guidance that had said the Bank "expects short- and long-term policy interest rates to remain at their present or lower levels," and indicated that it would conduct a broad-perspective review of monetary policy since the new BOJ Act came into effect in 1998, over a time frame of 12 to 18 months.

Rumors of a possible revision or abolition of the YCC had spread through the financial markets, with the memory of former governor Haruhiko Kuroda's knack for surprises still fresh in mind. However, in the end, the BOJ left policy on hold, in line with the consensus. The removal of forward guidance and a review of monetary policy had already been discussed in speculative media reports before the meeting, so probably did not come as a surprise. The BOJ's outlook for prices is a key input for its monetary policy decisions, and its Outlook for Economic Activity and Prices (Outlook Report), released at the same time as the policy decision, showed that the Bank has revised up the outlook for FY23 and FY24 (Table 1). Regarding CPI growth, the report noted "toward the end of the projection period, underlying CPI inflation is likely to increase gradually toward achieving the price stability target," but in the newly added projections for FY25, the median forecast for core CPI (excluding fresh food) is only +1.6%. At this point in time, we cannot conclude from the figures that the BOJ is in sight of achieving its target. Governor Ueda will talk about his interpretation of the data at his post-meeting press conference (held after this report was written).

Possibility of sustained inflation pressure

The Tokyo CPI for April was announced on 28 April, before the results of the monetary policy meeting were announced. Both headline and core CPI growth was +3.5% YoY, and the core-core CPI (excluding fresh food and energy) was +3.8%, with growth accelerating from March across the board (Figure 5). It appears that CPI inflation, which seemed to have peaked out due to government subsidies for electricity and gas, has yet to enter a steady decline. At the least, former Governor Kuroda's forecast that CPI growth would decline from February seems to have missed the mark. The Outlook Report shows the BOJ has revised up its outlook for FY23 but talk of price hikes for general consumer goods over summer is already in the news, suggesting further upward revisions could be in store.

Also, even if the passing on of prices due to the rise in overseas prices and the depreciation of the yen eventually subsides, we would argue that the norm of not being able to pass on prices in Japan has come to an end. Furthermore, the upward pressure on prices that accompanies wage increases, which the BOJ has long regarded as desirable, is likely to continue. We see a deep-seated view that this fiscal year's large wage increases were due to powerful government efforts, and we would not argue that this did not play a part. However, the BOJ's Sakura Report compiled at this month's meeting of BOJ branch managers revealed reports of labor shortages coming in from all across Japan. Some reports even said that labor shortages had contributed to missed profit opportunities. The current labor shortage appears to be largely due to demographics. In other words, the Japanese economy is becoming structured to secure human resources by raising wages. Relatively low wages coupled with the weak yen are making it difficult to secure foreign workers through the technical intern training program. In the absence of a sharp economic slowdown such as caused by the pandemic, we therefore see little prospect of an end to the labor shortage. In any case, we think the BOJ will have no choice for now but to focus on upside risks when revising its outlook for prices.

Next Outlook Report could present the opportunity for a change in monetary policy

Regarding the timing of a change in monetary policy, Governor Ueda told the Japanese Diet on 24 April that the BOJ expects strong price trends over the next six, 12, and 18 months, with price growth of around 2%, and that confidence in this outlook had increased. In addition, he revealed a focus on data given his background as an academic. We can interpret this as the idea that it is important for the forecasts shown in the outlook report, or more precisely, the forecasts of policy board members, to converge at around 2%. The figures in the latest report did not reach this level, suggesting that the timing of a change in monetary policy is likely to be at the monetary policy meeting at the end of July, when the next Outlook Report is scheduled for release. After the long public holiday in Japan, the government plans to lower the classification of COVID-19 to Category V, which is the same as for seasonal influenza. We expect this will result in further normalization of economic activity and stronger momentum for an economic recovery. If we position the BOJ's current outlook as a starting point to revise the outlook for prices, we think the details of the next Outlook Report are likely to support increased confidence in Governor Ueda's forecast that inflation will remain around 2% for the time being.

By the way, we think the revision of monetary policy will hinge on the removal of YCC. To date, Governor Ueda's thoughts on considering market functionality and reducing side effects have been influenced by the assumption that the YCC framework will be maintained. The YCC's revisions will be based, as was the case last December, on how to sustain the policy in the case of not anticipating that targets will not be reached. We therefore expect the BOJ will move from the current extraordinary easing measures to more regular easing policies once it concludes that it has reached its inflation targets.

We expect the BOJ will move to change monetary policy in July not just due to the release of the Outlook Report, but also because it will be aware of the political schedule. The Kishida government's approval ratings have been rising, and the LDP won four of five by-elections for seats in the Diet on the 23rd. Unsurprisingly, speculation is growing that a general election will be held ahead of next year's LDP presidential election. After the Hiroshima summit in May, it is rumored that the Diet will be dissolved near the end of the current session in June, and a general election will be held in July. This seems plausible. The next BOJ monetary policy meeting is scheduled for 15-16 June. The Diet will be in session on 21 June, and it is possible that the Diet will already be dissolved by that time, meaning the meeting will be held before the general election. According to the Nikkei Shimbun, since the new BOJ Act came into force in 1998, there have been no cases in which the BOJ moved to change monetary policy immediately before elections for both houses of the Diet. The BOJ will want to avoid the possibility that its monetary policy revisions could be interpreted as having a political motivation. We therefore expect any near-term changes in monetary policy will keep the political schedule in mind.

TABLE 1: OUTLOOK REPORT'S INFLATION FORECASTS

Source: BOJ, MUFG

FIGURE 5: TOKYO CPI (YOY)

Source: MIC, MUFG

Raising USD/JPY point forecast on push back in forecast for timing of YCC end

Now that the BOJ has decided to keep policy on hold, looking back at Governor Ueda's remarks since his inaugural press conference, it seems clear in hindsight that he had been signaling that the Bank would not change policy at this meeting. We note that Governor Ueda has maintained close dialogue with the market, as had been requested by Prime Minister Kishida before he took office as governor. The abolishment or revision of YCC would have come as a surprise by its very nature, but even still, Ueda had repeatedly talked about postponing any policy changes at the meeting or attached conditions to any changes. This would make the next meeting in June a likely time for changes in monetary policy. In light of this, Ueda could continue to push out a dovish message suggesting that the Bank will keep policy on hold in June as well. Naturally, this is unlikely to kill off expectations for a change in monetary policy sometime in the future but fading expectations for a change in monetary policy in the second half of April resulted in the EUR/JPY temporarily hitting an eight-year high, pointing to the prospect of yen weakening led by cross-yen rates in the near term. We had assumed that the BOJ would end YCC in April at the earliest, or if not, in June. We have revised our USD/JPY forecasts because we have pushed back our outlook for the timing of this. We make no change to our forecast range, which we think is reasonably wide, but revise up our forecasts for the end of each quarter by one yen.

QUARTERLY FORECAST RANGE AND PERIOD-END FORECAST

	May-Jun 2023	Jul-Sep	Oct-Dec	Jan-Mar 2024
USD/JPY	124.0～140.0	122.0～138.0	120.0～136.0	118.0～134.0
Period-end forecast	131.0	129.0	127.0	125.0

Our forecast range estimates the high and low for each quarter. The period-end forecast is our forecast for USD/JPY at 17:00 New York time at the end of each quarter.