JPY

In our opinion, relative interest rate differentials should continue to shift incrementally in the yen’s favour over the next year. While central banks appear set to maintain restrictive policy settings to ensure inflation is tamed, we doubt further interest rate hikes will be delivered. Indeed, with central banks evolving toward a more data-dependent and risk management-focused approach as growth slows, labour markets loosen, and inflation moderates, expectations about the next easing cycle should intensify. This is likely to see bond yields outside of Japan decline as in past cycles, when rates have fallen once it became clear the monetary tightening...

A more bearish backdrop for the yen might unfold if the Bank of Japan holds firm, ignoring elevated inflation and indications that price growth could persist. In this scenario, wide interest rate differentials should continue to depress the yen: especially if risk sentiment remains buoyant, inflation cools, and global growth slows whilst avoiding more sinister outcomes. USDJPY and Japan Trade-Weighted Index

While yield spreads in absolute terms look set to remain skewed against the yen for some time, we believe the bulk of the adjustment has played out. The balance of probabilities is tilted toward differentials narrowing and the yen recovering further. As other central banks, such as the Federal Reserve, European Central Bank, and Bank of England, contemplate a policy easing cycle, the Bank of Japan appears set to embark on a normalisation path. Modest tweaks, such as the formal ending of yield curve control, may well see markets discount larger steps further out. We are projecting the yen to...