The Yen in Flux: Where Is It Headed? Market Carte, October Issue

USD/JPY was in the upper ¥159s at the start of the month, but yen appreciation gathered pace by the 8th, briefly sending it down to the ¥152 range. This was attributed to market attention being drawn to the possibility of faster Bank of Japan rate hikes and a change in the government's expansionary fiscal stance following comments by US Treasury Secretary Bessent on Japan's monetary and fiscal policies. The market began to question the validity of the narrative of yen weakness driven by fiscal expansion and a behind-the-curve monetary policy, prompting an unwinding of yen-selling positions and what appeared to be new yen buying.

More recently, however, USD/JPY has moved back toward yen weakness, reaching the upper ¥154s against a backdrop of higher oil prices and growing expectations of US rate hikes following upside surprises in inflation data. The key factors for the outlook are the Bank of Japan's rate policy and the government's fiscal policy. As the market is already pricing in the former, a more hawkish stance than expected is not considered likely to provide a major new catalyst for yen appreciation. By contrast, the latter is seen as likely to fuel expectations of fiscal expansion, with a succession of expansionary measures under discussion, including a consumption tax cut, increased defense spending and next fiscal year's budget, which will include investment for growth.

The continued prospect of a trade deficit in Japan, against a backdrop of the Federal Reserve's hawkish stance and higher oil prices, is considered likely to produce a rebound toward yen weakness through year-end. USD/JPY is forecast to be around ¥157 in three months. Long-term interest rates are expected to remain in the low 3.0% range and to reach around 3.1% in three months, slightly above current levels.