Insights into USD and JPY Dynamics for 2023

The US dollar strengthens post-Williams’ comments, quelling Q1 rate cut speculations. Despite optimism, caution lingers with expectations for significant 2023 rate reductions. A potential USD rebound against the euro and pound is conceivable amid European uncertainties. The yen’s resilience ahead of the BoJ’s year-end update challenges USD/JPY dynamics, prompting cautious market consideration.

USD Unravelling the Fed’s Stance and Global Economic Dynamics

The US dollar maintains a marginally robust position, propelled by a relief rally sparked by New York Fed President Williams’ comments. Williams dismissed market speculations of imminent Fed rate cuts in Q1 next year, asserting in a Friday CNBC interview that rate discussions are premature. While this suggests the Fed’s reluctance to cut rates in March, market participants remain cautious, retaining expectations for substantial rate reductions in 2023.

As of now, the US rate market anticipates approximately 21 basis points of cuts by the March 20th FOMC meeting and around 145 basis points by the end of the next year. Following the recent FOMC meeting, market confidence grows in the likelihood of Fed rate cuts in response to slowing inflation. The upcoming November PCE deflator report is awaited to furnish evidence of diminished inflation pressures, reinforcing the Fed’s conviction in returning inflation to their 2.0% target.

The pessimistic adjustment of Fed policy expectations amplifies downside risks for the US dollar in early 2023. Caution is advised against actively seeking further dollar weakness in the short term. A potential rebound against the euro and pound is conceivable, considering the US rate market has already factored in expectations for significant Fed rate cuts. Additionally, deteriorating economic data in Europe may prompt dovish policy shifts from European central banks early next year.

Indicators of accelerated core inflation decline, coupled with ongoing economic risks in the eurozone, could sway the ECB toward a departure from restrictive rate levels. Even in the UK, where the BoE is concerned about persistent inflation risks, recent developments signal disinflation. Given these circumstances, the window for additional US dollar weakness against the euro and pound may be transient.

Among major currencies, the yen appears poised to outperform as the Fed, ECB, and BoE prepare for rate cuts next year.

JPY BoJ’s Year-End Policy Update and Yen’s Resilience

The Bank of Japan (BoJ) is set for its final policy update this year, with expectations tempered after a Bloomberg report downplayed the likelihood of an immediate shift from the current negative rate policy. Although the report initially triggered a yen sell-off last week, losses have been recovered, attributing the yen’s rebound to expectations of significant rate cuts by other central banks, narrowing the policy gap with the BoJ.

Anticipation surrounds the BoJ’s policy meeting, with a focus on the updated policy statement and Governor Ueda’s comments. Speculation suggests the BoJ might reinforce the yen’s upward momentum by removing negative rates in January, a move not seen since early 2016. Analysts scrutinize potential changes to the statement, particularly the removal of the easing bias, signalling a substantial shift with repercussions in interest rates and FX markets.

While adjustments to the assessment of the economy or inflation seem less likely, developments prompting tweaks related to inflation and wages may indicate progress. Governor Ueda’s press conference could offer insights into progress toward price stability and wage growth, allowing flexibility for a potential policy change in January.

The current yen strengthening marks a significant correction since last year. Unexpectedly hawkish signals from tomorrow’s announcement could further advance the yen. Leveraged Funds still hold substantial short yen positions, and while fundamentals may play a reduced role in FX movements, liquidity and positioning remain crucial. Though USD/JPY has experienced a 10-point drop from the November high, significant further downward moves are deemed less likely. Governor Ueda’s status-quo message may prompt renewed selling, with global yields also under scrutiny.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.

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