Japanese Yen Retains Highest Chances to Further Weaken against Dollar Among Peers

The U.S. dollar hit its highest level in nearly five years against all major currencies thanks to wider expectations of the radical change in the Fed’s monetary policy. The DXY Dollar Index reached an unprecedented 96.21 pts, which doesn’t look good when matched with current dollar-inherent inflation. Apparently, investors believe or try to convince themselves of the possibility of impending serial rate hikes.

There is only one known economy that benefits from the continuing dollar ascension – Japan. The U.S. dollar surged to 115.85 yen for the first time since January 11, 2017, as 10Y Treasury yields jumped almost 20 basis points to hit 1.725% for the first time since April 2021. Money markets look to have fully priced in the first rate hike in the U.S. by May and two more ones by the end of 2022. The convincement in the later two looks all but a miraculous self-delusion.

Meanwhile, the market will have been evaluating a more aggressive U.S. rate hike scenario for some time – or at least the odds of such an increase – in 2022, and this definitely remains a key support for the dollar. The key question is where inflation is going, and where will it peak?

As this happens, the Japanese yen will likely keep dropping on temporarily weakening concerns over the omicron, prompting investors to withdraw from safe havens and switch back to riskier assets. Hence, JPY's renewed weakness stems from the general consensus that the omicron variant may proliferate quickly, and is likely to be less dangerous than the delta variant, and thus may pose less of a drag on global economic growth. While the surge in coronavirus cases fueled by the omicron variant continued to impact global travel and public services and delay the reopening of some U.S. schools after the holidays, investors remained optimistic about the minimum restrictive measures. On Monday, the U.S. Food and Drug Administration authorized the use of the third dose of Pfizer’s and BioNTech’s Covid-19 vaccine for children aged 12 to 15 and reduced the required periodicity for all boosters from six months to five months after the initial vaccination.

Given the combination of higher stock prices and Treasury bond yields, the current dollar/yen rate looks undervalued. The yen may fall to its new historic minimum, 119 per dollar by the Q4 the lastest, according to a note from Mizuho Bank. As to BNP Paribas and Commerzbank – the latter two expect the Japanese currency to hit 118 sometime during the same period.

Back to the dollar and yen, assuming the U.S. Treasury yields remain elevated, there is nothing on the charts that could stop the rise to 118.00 in the coming weeks. Options pricing suggests the dollar could accelerate the rally against the yen, which, as we already mentioned, has already pushed it to its highest level since 2017. While the yen's volatility skew shows that demand for long-range Japanese currency strikes is still priced at a premium, it should be borne in mind that the curve is self-resolving after a very steep move in late November when omicron concerns first took over as a major market driver; if at the end of January 2022 the risk reversal approaches the recent averages, the current move could become even more rampant.