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Yen weakens amid rising US yields and carry trade activity

usdjpy analysis

The Japanese yen weakened on Wednesday to its lowest level in four weeks against the dollar, influenced by rising yields in the US. Over recent weeks, the yen has seen a gradual decline, contrasting with the more abrupt drops that prompted Tokyo's interventions at the end of April and the beginning of May.

The yen's steady decline is noteworthy because it indicates a persistent trend rather than a sudden market reaction. This gradual weakening reflects underlying economic factors and market sentiments, such as the strength of the US economy and investor behavior in response to shifting financial conditions.

Earlier this month, weaker US consumer inflation data had caused the dollar to weaken, as lower inflation reduces the likelihood of aggressive monetary policy tightening by the Federal Reserve. This initially provided some support for the yen. However, since then, US Treasury yields have resumed their rise, with the benchmark 10-year yields reaching the highest level in nearly four weeks at 4.57%.

Rising yields typically attract investors seeking better returns, thus strengthening the dollar against other currencies, including the yen. This dynamic shows how interconnected economic indicators and monetary policy expectations are, influencing currency values on a global scale.

Regarding Asian currencies, the relief rally following the US CPI data is starting to wane. The initial positive reaction was driven by hopes that lower inflation might lead to a more dovish stance from the Federal Reserve. However, those expectations are being scaled back as recent economic data and unstable bond auctions drive up yields, exerting pressure on the yen and the Chinese yuan.

Investors are becoming cautious as the outlook for US monetary policy remains uncertain, leading to increased volatility in Asian currency markets. This illustrates the sensitivity of regional currencies to US economic policies and data.

A poor auction of two-year and five-year US Treasury bonds raised concerns about demand for US government debt. Weak demand in these auctions can indicate investor anxiety about the US fiscal outlook or higher expected future interest rates, which typically push bond prices down and yields up.

Additionally, Tuesday's data showed an unexpected improvement in US consumer confidence in May, further strengthening the dollar. This boost in consumer confidence suggests a robust US economy, which supports the case for higher interest rates, thus making the dollar more attractive to investors and adding downward pressure on the yen.

The yen is under significant downward pressure due to high carry trade activity amid low currency volatility. In a carry trade, investors borrow in a currency with low interest rates (like the yen) and invest in assets in currencies with higher interest rates, seeking to profit from the interest rate differential. The EUR/JPY has consistently surpassed the 170 level for the first time in recent times, while the GBP/JPY has exceeded the 200 level for the first time since 2008.

These milestones indicate strong interest in carry trades involving the yen, reflecting its role as a funding currency in global financial markets. The yen's low yield makes it an attractive option for this strategy, but it also means that high demand for carry trades can significantly weaken the yen.

Carry trade activity has also played a significant role in the yen's decline, as investors borrow in low-yield currencies to invest in higher-yield assets. This strategy increases the supply of the yen in global markets, driving down its value. The continuation of the upward trend in USD/JPY seen since May 3 may persist, although the chances of a clear breakout above the 160 area in the next 2-3 weeks are slim.

This psychological barrier is significant not only for traders but also for policymakers, as surpassing it could prompt intervention to stabilize the yen. The interplay between market forces and potential government actions adds another layer of complexity to currency trading dynamics.

usdjpy analysis
USD/JPY daily chart, MetaTrader, 30.05.2024



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