Growing risks of the global trade war limits the potential of the USD/JPY rally
A strong data on the US labor market in May scared the USD/JPY bears. Encouraged by the prospects of the US economy and the Fed's desire to follow the path of a leisurely monetary policy normalization, investors were getting rid of safe haven assets, which resulted in an increase in the yield of treasury bonds. It is the dynamics of the rates of the US debt market that is the main driver for the change in the USD/JPY quotes: while BoJ keeps the yield of Japanese bonds at zero level, the yen rate is sensitive to the flow of capital from Asia to the US and vice versa.
Dynamics of the USD/JPY and US Treasury yields
Source: Trading Economics.
The analyzed pair did not react to the message about the decrease in purchases of bonds with maturities of 5-10 years by ¥20 billion ($ 183 million) to ¥430 billion within the QE. In February, the same information led to a rapid strengthening of the yen. Then the market seriously counted on the end of the quantitative easing program. Now everyone understands that the decline in asset purchases is the reaction to the decline in yield on US Treasury bonds. US bonds showed increased sensitivity to a fall in the likelihood of four acts of monetary restriction by the Federal Reserve in 2018, an increase in political risks in Italy and an increase in the chances of a global trade war. Japanese debt obligations followed, so the BoJ's actions look quite logical. It is still too early to talk about the normalization of monetary policy. Moreover, it brings dividends to the budget.
We all know Japan as a country with an aging population. More and more financial resources are required to pay the pensions, which expands the budget deficit and contributes to the build-up of public debt. Based on its ratio to GDP, the Land of the Rising Sun has no equal. It is clear that money is needed to service such a colossal debt, and the lower the rates on Japanese bond auctions, the less costs the government will incur. The fact that the policy of targeting the yield curve of BoJ has already saved Tokyo $45 billion, allows us to state that the central bank will notgive it up so easily.
Debt of G-7 countries,% to GDP
Dynamics of Japan's debt and its serviving costs
Thus, the Bank of Japan will continue to make great efforts to restrain the growth of local bond yields, and the rate of the US dollar against the yen will continue to be determined by the rates of the US debt market. If in April-May, they grew against the background of increased risk of inflation and the likelihood of the four monetary restrictions by the Federal Reserve in 2018, now the attention of investors is increasingly returning to the global trade war. Washington is playing its own game, which is likely aimed at reducing the cost of borrowing in the United States. This circumstance makes the USD/JPY rally potential limited and allows using the previous pair sales strategy for growth. The medium-term targets are the levels 108 and 107.
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