The JPY is worth 25 percent less than two years ago – what comes next?

The second big story in the FX market in the last couple of years was the Japanese Yen (JPY)’s steady decline. It came because the Bank of Japan was the outlier among major central banks – the only one that did not raise rates after the COVID-19 pandemic and rising inflation.

As a result, the yen lost ground across the FX dashboard. According to a recent article in the Financial Times, the yen rate follows the gap in US-Japan interest rates.

As such, it is no surprise that the USD/JPY exchange rate climbed to 150 in the last part of 2022 after trading below 110 just one year later. Similar market movements may be spotted on other currency pairs, such as the EUR/JPY or the GBP/JPY.

In other words, the interest rate differential works to the JPY’s detriment, and fighting the trend has been costly for contrarian traders.

But now the big question is, what happens next?

The Fed in the United States has already paused the interest rate hikes. Inflation is coming down quickly. If the US changes course and cuts the funds rate later in the year or in early 2024, the gap in US-Japan interest rates will rapidly shrink.

Will the USD/JPY exchange rate come down too?

USD/JPY to make a new high above 152

While the recent decline from 144 was quite abrupt, buyers will likely emerge again. The technical picture favors a new high above 152 while the market holds above the 132 support area.

A bullish triangle broke higher in the year’s first half, and then the market rallied. Providing the 132 level holds, the path of least resistance is for the market to make a new high.

On its way higher, it should overcome the 144 pivotal level. On such a move, more buyers should emerge, and a new high should come quickly.

The fundamentals also favor a higher exchange rate. The weak yen reflects the Japanese exporters that lost their competitiveness. Weak domestic demand does not help either, and the Bank of Japan’s actions will likely have only a temporary effect.

In real terms, the yen is the weakest it has been in 50 years. Household spending is roughly the same as it was a decade ago, suggesting that the weak currency contributes to a weaker economy.

The shrinking of the US-Japan interest rate gap might not be enough to bring the USD/JPY exchange rate down as easily as it moved higher. As such, the path of least resistance in the short and medium term remains for the exchange rate to climb to new highs.