Yen Bulls See Turning Point After Biggest Annual Drop Since 2014

(Bloomberg) -- The decline in the yen, which recorded its biggest annual slump against the dollar in seven years, may be nearing an end if the history of Federal Reserve rate increases is any guide.

The Japanese currency has shown a recent tendency to strengthen at the beginning of Fed hiking cycles -- in a “buy the rumor, sell the fact” manner -- sometimes bringing an extended period of weakness to an end. The yen fell more than 10% against the dollar in 2021 as traders positioned for the U.S. central bank to raise interest rates as soon as May while the Bank of Japan stands pat.

This time round factors such as a potential reopening of Japan to overseas tourists, U.S. mid-term election risk and speculation over who will replace BOJ governor Haruhiko Kuroda could give an additional boost to the yen, just as the hiking cycle gets underway. There is also the possibility of traders pricing in a policy error by the Fed, which could lend a haven bid to the Japanese currency.

“The dollar-yen tends to rise until the Fed raises rates and fall when it actually happens,” said Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co in Tokyo. “The dollar-yen is seen rising to around 117 around mid-2022 and peaking when the U.S. starts raising rates.”

One Twenty

The yen is likely to remain under pressure at least during the first part of the year, with a move above 120 per dollar possible, according to Yujiro Goto, head of foreign-exchange strategy at Nomura Holdings Inc. That would mean at least another 4% decline in the currency, which traded around the 115 per dollar level in Asia trading Monday.

The widening growth gap between the U.S. and Japan, thanks in part to tighter restrictions to control the spread of the coronavirus, will continue to pressure the yen, according to Daisuke Karakama, chief market economist at Mizuho Bank Ltd.

“Japan keeps restrictions that weigh on economic activities and there is no prospect that Japan can fill this difference in 2022, eroding the appeal of Japanese assets and keeping the currency the weakest of major peers,” he said. “I'm basically a dollar bull and see Japan staying a laggard among developed nations.”

Speculators seem to have the same view, with trader positioning set to end 2021 with a sizable net short yen position, according to the latest Commodity Futures Trading Commission data.

Still, that positioning could come under pressure this year if there is even the slightest hint of Japan joining global peers and pulling back from its unprecedented easy monetary policy stance.

“Most players are seen betting the BOJ's policy shift is off the table semi-permanently, so any doubts, not real action, about that could move the yen given the massive short positions accumulated,” JPMorgan's Sasaki said.