Investing.com – The yen is struggling to hold on to any gains against the US dollar, even after official intervention last week, but UBS still sees potential for the pair to decline in the medium term.
At 10:30 EST (14:30 GMT), USD/JPY was trading 0.1% higher at 155.64 yen, just below the 160 yen level seen last week – the weakest level for the yen against the dollar since 34 years old.
This weakness comes despite Japanese authorities spending what is believed to be about $60 billion last week to support its currency.
Additionally, the Bank of Japan issued its strongest warning yet on Wednesday, with Governor Kazuo Ueda stating that it may take monetary policy measures if the yen's decline affects prices significantly.
UBS took a look at the period from 2006 to 2007, when the yen was also under pressure as US yields rose and carry trading was in full swing.
The Swiss bank noted that when US yields reached very attractive levels (e.g., >5%) compared to lower Japanese yields, global carry trades continued to push USD/JPY higher, even as the Fed held rates low. The interest remains unchanged.
In addition, when the Bank of Japan finally began raising interest rates (by 25 basis points each in July 2006 and February 2007), it sparked declines in the USD/JPY, but failed to reverse global trading forces. Return based.
Finally, the pairing peaked in June 2007, three months before the Fed's first interest rate cut in September 2007. This is because markets tend to move in advance, once US data starts to weaken.
This suggests that as long as US data remains strong, reducing expectations of interest rate cuts from the Fed, there will be upward pressure on USD/JPY. However, we also believe that it is becoming more difficult for the markets to push the pair higher, as the exchange rate has reached levels that are painful for Japanese officials.
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Furthermore, the level of JPY short positions is testing record levels last seen in 2007, which also coincided with the peak of the USD/JPY.
“In this context, we maintain our view on a medium-term decline in the USD/JPY pair,” the bank said. “We expect the Fed to cut interest rates starting in September, and the Bank of Japan to raise rates in either July or October, with further tightening likely in 2025. A narrowing of the yield spread would put downward pressure on the pairing, so In line with what happened in 2007.
The bank expects the USD/JPY pair to fall to 148 yen by the end of the year, saying that a rise to 160 yen would again attract potential currency market intervention.
However, if strong US data forces the Fed to raise interest rates this year, the USD/JPY pair is likely to surpass the 160 level.