Japanese Yen lags peers despite post-election decline in US Dollar

• USD/JPY pares earlier declines as broad US Dollar weakness delivers limited gains for the Japanese Yen.
• Five-week lows for the US Dollar follow US midterm results.
• Wide rate differentials cap Yen gains despite a hawkish BoJ.

The US Dollar (USD) has fallen to five-week lows. Following the US midterm election results, its decline leaves USD/JPY trading with a downward bias on Wednesday. The Japanese Yen (JPY), however, has surrendered much of its earlier advance and trails most major peers, struggling to gain from the Greenback’s weakness.

After touching an intraday low of 157.39, USD/JPY stands near 158.32 at the time of writing, a daily decline of 0.25%.

A Democratic victory in both houses of Congress has put the US Dollar under pressure. The result paves the way for divided government, increasing the risk of political deadlock in Washington and uncertainty over fiscal policy. Near five-week lows, the US Dollar Index (DXY) is trading around 101.40, down 0.44% on the day. The index measures the Greenback against a basket of six major currencies.

For MUFG/BTMU analysts, the recent US mid-term 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 relief 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%, Japan still faces a substantial interest rate gap with other major economies. The BoJ continues to tighten gradually. Elsewhere, inflationary pressure arising from the Middle East energy shock has led major central banks to increase rates, and further rises are expected.

Expected persistence in these wide rate differentials leaves the Yen at a yield disadvantage, limiting the support provided by the BoJ’s hawkish position. Japanese officials’ warnings of intervention nevertheless temper traders’ willingness to bet against the currency. On Monday, Finance Minister Satsuki Katayama said Japan would take action against disorderly or excessively speculative currency movements.

According to MUFG/BTMU, “intervention in last July / early August has distorted the link with rates,” while the Yen’s performance also 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 remains cautiously positive: “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.”