Japanese Yen lags peers despite US Dollar sell-off following election

• Broad US Dollar weakness provides little support for the Japanese Yen, allowing USD/JPY to recoup some earlier losses.
• The US Dollar falls to five-week lows following the US midterm election results.
• The Yen’s advance remains constrained by wide interest rate differentials, notwithstanding the BoJ’s hawkish stance.

Five-week lows in the US Dollar (USD), reached after the US midterm election results, leave USD/JPY trading with a downward bias on Wednesday. Yet the Japanese Yen (JPY) has made little headway from the Greenback’s weakness: it has surrendered much of its earlier advance and is lagging most major peers.

Having touched an intraday low of 157.39, USD/JPY stands at around 158.32 at the time of writing, a decline of 0.25% on the day.

Democrats’ victory in both houses of Congress paves the way for divided government, weighing on the US Dollar as the prospect of political gridlock in Washington increases and fiscal policy becomes less certain. At around 101.40, the US Dollar Index (DXY) is down 0.44% on the day, close to five-week lows. The index measures the Greenback against a basket of six major currencies.

In the view of MUFG/BTMU analysts, the recent US midterm election result is “unlikely to impact the US-Japan relationship and the strong message emanating from Washington over its opposition to the continued weakness of the yen.” They see little respite in the Yen’s latest advance, emphasising that “the reprieve for the yen is marginal (today’s gain is USD-related) with the rates/FX link for the yen still relatively weak.”

With the Bank of Japan’s (BoJ) policy rate at 1.25%, a substantial interest rate gap persists between Japan and other major economies. The BoJ continues to tighten policy gradually. Elsewhere, however, inflationary pressure arising from the Middle East energy shock has led major central banks to raise rates, and additional increases are expected.

Expectations that rate differentials will stay wide therefore leave the Yen at a yield disadvantage, limiting the benefit of the BoJ’s hawkish stance. Japanese officials’ warnings of intervention nonetheless discourage traders from taking positions against the currency. On Monday, Finance Minister Satsuki Katayama said Japan would respond to disorderly or excessively speculative currency movements.

According to MUFG/BTMU, “intervention in last July / early August has distorted the link with rates,” although the Yen’s performance still points to more deep-seated influences: “what the movement of the yen does indicate is that there are still some structural flows that continue to weigh on yen performance and those flows could well be slow to change.” Their medium-term assessment nevertheless retains a cautiously positive tone: “we still suspect the yen is close to a turning point and market rates and/or policies by the government to encourage greater sums of capital to remain in Japan should have a positive impact on the yen.”