USD/JPY plunged to its lowest level since early May on narrowing US-Japan 2-year bond yield spreads and a sharp pick-up in financial market volatility.

BOJ is unlikely to tighten more

“Rising odds of a more aggressive Bank of Japan (BOJ) tightening cycle and expectations of Fed easing dragged US-Japan 2-year bond yield spreads to the lowest since May 2023.”

“Meanwhile, rising FX volatility has raised the cost of shorting JPY and triggered a rapid unwind in yen carry-trades. 1-month and 1-week implied JPY volatility surged to more than a two-month high. Moreover, the tech-led global stock market sell-off pushed the VIX index to a three-month high, benefiting safe-haven currencies like JPY and CHF.”

“We expect USD/JPY to hold above its 200-day moving average (151.54). First, the BOJ is unlikely to tighten more than is currently priced-in. Japan underlying inflation is in a firm downtrend, and negative real cash earnings suggest consumption spending will remain weak.”