The Japanese yen was recently in the news for triggering a brief period of panic selling in global stock markets, triggered by the Bank of Japan’s decision on July 31 to raise its policy interest rate from 0-0.1% to 0.25%.
Incidentally, the following day, US Purchasing Managers’ Index (PMI) data showed that it had fallen sharply to 46.8 in July from 48.5 the previous month. Separate data released later that week showed that the US unemployment rate had jumped to 4.3% in July. Both of these data points rekindled fears of a US recession and raised the possibility that the US Federal Reserve would cut interest rates early at its September meeting.
In other words, Japan’s interest rate hike at a time when the US was preparing for a rate cut cycle caused a sharp drop in USDJPY. After this event, the currency pair (USDJPY) plummeted by over 7% from 153 to 142. As a result, global stock markets fell. The Dow Jones Industrial Average fell by about 6% from about 41,000 to 38,500 in the days following the Japanese rate hike. Japan’s benchmark index fell by about 20% in the same period.
The main driver of this stock selloff was the so-called yen carry trade: With interest rates in Japan at zero for a long time, investors borrowed from Japan (in yen) and invested in high-yielding assets such as domestic and foreign stocks.
Unconfirmed reports suggest the yen carry trade could reach $20 trillion, with some reports also saying a significant portion of that trade has already been unwound.
However, the absolute size of the yen carry trade is unknown and it is not easy to estimate how much of an impact it will have on global markets. What can be done for sure, however, is to see how far the yen will rise from its current levels and how that will impact the Nifty and the rupee.
For the purpose of our forecast, we have taken some key indicators that influence the yen’s movements and applied technical analysis to them.
It is important to note that this forecast is long-term, at least a year out, so the yen’s path to the target level will likely be gradual rather than as abrupt as it has been recently.
The analysis is as follows:
US-Japan yield gap
The yield differential between two countries is one of the main drivers of currency movements. The difference between the US 10-Year Treasury Yield and the Japanese 10-Year Treasury Yield (US 10-Year Treasury Yield minus Japanese 10-Year Treasury Yield) has a very strong directional correlation with the USDJPY pair, meaning that as the difference increases, USDJPY rises and vice versa. This is evident from the chart below.
The US-Japan 10-year Treasury yield spread (2.92%) appears to have plateaued around 4% and is declining. It is currently at 2.92%. Strong resistance is at 3.3-3.4%. The most recent support is at 2.9%. A short-term bounce from this support to 3.3-3.4% cannot be ruled out. After that, however, the spread could decline again. That move could break below the 2.9% support. Such a break could push the US-Japan 10-year Treasury yield spread to 2.4% or even lower.
Therefore, USDJPY may see a short-term upswing if the yield gap rises to 3.3-3.4%, but eventually, the pair may decline again and experience a new downturn as the yield gap falls back to 2.4% or below.
The Yen and Fed Rate Cuts
A September interest rate cut by the Federal Reserve is now all but certain, with Fed Chairman Jerome Powell saying the time has come for a policy adjustment in a speech at the Jackson Hole meeting on Friday.
Some in the market are expecting a 50 basis point (bps) cut next month, compared with the usual 25 bps. CME Group’s FedWatch tool gives a 76% chance of a 25 bps cut in September, and a 53% chance of another 25 bps cut in November. But the Fed’s economic outlook released in June said it expects just one rate cut this year.
Either way, the US is now in a rate cutting cycle. As you can see from the chart above, previous rate cuts by the Fed have caused the USDJPY pair to fall throughout the rate cutting cycle. In some cases the USDJPY fall started late, but ideally the currency pair fell hard.
Therefore, if the Fed starts cutting interest rates, USDJPY may fall further in the future. The amount of USDJPY fall will depend on how long the interest rate cutting cycle lasts.
Inflation in Japan
Japan’s Consumer Price Index (CPI) is expected to peak in January 2023 and is on a downward trend. The CPI will reach 4.3% in January 2023 and is at 2.8% as of July this year. The Bank of Japan predicts that the CPI will be 2.5% in 2025.
However, as you can see from the graph above, the decline in the CPI took several years to bottom out, so Japan’s CPI may have room to fall further from here, perhaps to 1.5-1% or even lower over the next few years.
USDJPY has a strong directional correlation with the CPI, so as Japan’s CPI is expected to decline over the next few years, USDJPY is likely to continue to decline along with it over the next few years.
On the chart
All the above factors indicate that the USDJPY pair is likely to fall further in the coming days. To know how far it will fall, take a look at the price chart of the USDJPY pair and do your own analysis.
The outlook for the USDJPY pair has become bearish due to the sharp drop below 150 after the Bank of Japan rate hike. Strong bounce from lows of 141.66 However, this did not hold and the pair has fallen again from around 150 over the past few weeks.
Immediate resistance is at 150. Above that, there is strong resistance in the area of 151 to 152. Support is currently at 144. Sideways consolidation between 144 and 150 or 152 could continue for a month or two.
Ultimately, we expect USDJPY to break above 144 in the coming months. Such a breakout would be very bearish, as the USDJPY pair could fall to 130-128 over the next year.
Below 144, intermediate supports are 139 and 132. Hence, the path forward looks like this:
* First, it has remained stable between 144 and 152 for the past few months.
* It then fell below 144 to 139
* We then see a corrective rebound from 139 to 144-145 to 148.
* And finally, it goes from around 145 or 148 down to 132-130
* If the support at 132 holds for the first test, a corrective bounce from 132 to 136-137 before moving back to 130-128 is likely.
What the USDJPY drop means for Indian markets
Nikkei Stock Average and Nifty50
To understand how the drop in USDJPY from 130 to 128 will impact the Nifty 50, we first need to look at where the Nikkei 225 is headed going forward.
USDJPY and the Nikkei Stock Average have a strong directional correlation, so if USDJPY falls to 130-128 in the future, the Nikkei Stock Average may fall accordingly.
On the chart, the Nikkei 225 has a strong resistance level around 42,000-43,000 yen. A rise above 43,000 yen seems unlikely at this point. If the USD/JPY can rise to 150-152 yen in the short term, the Nikkei 225 could rise towards 42,000-43,000 yen in the coming months.
On the downside, as long as the Nikkei average remains below 43,000 yen, it could eventually aim for 33,000 yen or even 31,000 yen.
Ratio analysis of Nikkei 225 vs Nifty 50 will help determine where the domestic benchmark index is headed based on the predicted fall in Nikkei 225.
The ratio between the Nikkei and Nifty 50 is currently at 1.55. It can go up to 1.6 from here. So, if the Nikkei rises towards 43,000, the Nifty 50 can rise to 26,875 and the ratio can go up to 1.6.
Eventually, the ratio may reverse from 1.6 and fall to 1.4-1.3 in the long run. So, if the Nikkei falls to 31,000, the Nifty 50 may fall to 23,850 or 22,150 and the ratio may fall to 1.4-1.3.
Hence, broadly the Nifty movement may rise to 26,875 and then fall towards 23,850 or 22,150. It should be noted that the levels reached by the Nifty are based on ratio analysis.
Yen and Rupee
First, we will make a prediction for the JPYINR cross to speculate on where the Indian Rupee (USDINR) is headed. JPYINR, currently at 0.58, has recently risen considerably from around 0.52. It would be positive if it could not sustain a decline below 0.54 and bounce back strongly from 0.54. Therefore, there is a high probability that the JPYINR cross will break through the immediate resistance at 0.59. Such a breakout could see the cross rise initially to 0.64 and eventually to 0.70 in the long run.
So, if JPYINR rises to 0.64 and USDJPY falls to 139, the Indian Rupee can fall to 89. If JPYINR then rises to 0.70 and USDJPY falls to 132, the Indian Rupee will fall to 92.40. From a long-term perspective, the Rupee is expected to fall below 90.
