OCBC Bank’s report looks at the continued weakness of the Japanese yen (JPY) due to uncertainty surrounding Japan’s elections on February 8. The behavior of Japanese government bond (JGB) yields shows different views on Japan’s fiscal situation. With the upcoming election, the risk of verbal intervention to support the yen may increase. Concerns over fiscal policies could limit how much the USDJPY rate moves, both before and after the election. Typically, worries about fiscal policies weaken the JPY and push long-end JGB yields higher. The current quietness in the JGB market, paired with a weaker yen, suggests that bond and foreign exchange markets have differing opinions on fiscal direction after the election. If Prime Minister Takaichi’s party wins convincingly, he may gain more power to push for fiscal stimulus, which could exert more pressure on the JPY. However, if his party wins clearly, it might stabilize the JPY by reducing the calls for looser fiscal or monetary policies. With the election just days away, the yen is under significant pressure due to uncertainty about future government spending. This political risk is the main focus for currency traders this week, as the outcome will likely influence the yen’s direction in the near future. The yen’s fundamental weakness is evident when considering the interest rate gap. The Bank of Japan’s policy rate is at -0.1%, while the U.S. Federal Reserve’s rate exceeds 4%. This wide gap is the main reason the USD/JPY exchange rate has recently been above 162. The impending election adds another layer of uncertainty to an already weak currency. Reflecting this tension, one-week implied volatility in the USD/JPY options market has surged to over 15%, much higher than its recent average of 9%. This indicates that traders are willing to pay more to protect themselves against, or take advantage of, a sharp move in the currency after the election results—signaling an expected significant price change. At these higher exchange rates, there is a real risk that the government could intervene to buy yen. We observed such intervention in autumn 2024 when the rate first exceeded the 160 level. This history should make traders cautious about how much higher the USD/JPY can go before and immediately after the election. A decisive win for the ruling LDP coalition would likely empower the Prime Minister to advocate for fiscal stimulus, which would further weaken the yen. On the other hand, a less clear majority might lead to a more cautious approach, reducing the need for aggressive spending and helping stabilize the currency. Interestingly, while the yen struggles, the Japanese government bond market has remained relatively stable. This suggests that bond investors may hold a different, less anxious perception of the country’s fiscal outlook compared to currency traders. If we start to see bond yields rise, it would confirm that negative sentiment about the yen is spreading.

here to set up a live account on VT Markets now