Bank of Japan. Image © Adobe Stock.
The Japanese yen should be stronger, but hedging by equity investors is proving a headwind.
The Bank of Japan has raised the policy rate to 1.0%, the highest level since the late 1990's, and this should provide support for the yen going forward.
According to Citi, the policy rate spread with the US has declined below 3% to 2.75%.
"Historically, the JPY carry trade has been unwound when the interest rate spread has been in the 2%-3% range, and the USDJPY has tended to decline in this zone," say strategists in a post-BoJ decision note.
Although the stars are aligning for a stronger yen, the currency market has thus far failed to engage.
Citi explains this is because Japanese equities are at historic highs, and this gives rise to considerable yen-sell hedging demand that puts upward pressure on the USDJPY.
"Even so, since 2024 upward trends in this currency pair have been capped at around ¥160/$, around where yen weakness has tended to come under control," adds the note.
Bigger picture, Citi says intervention, the normalisation of BoJ monetary policy and resulting contraction in the monetary policy gap with the U.S. should help control JPY weakness.
