HSBC’s analysis shows that the USD/JPY exchange rate is fairly valued between 146 and 152. However, changes in politics, economics, and policy could cause the JPY to recover. Important factors include a possible trade agreement between the US and Japan, potential easing by the Fed, or direct intervention by Japan in currency markets. Factors that could strengthen the JPY include a trade deal that lowers tariffs, which may ease fiscal concerns and raise hopes for a Bank of Japan (BoJ) rate hike. The JPY’s Real Effective Exchange Rate (REER) is about 10–35% below historical levels, suggesting it could appreciate. Many BoJ investors are under-hedged, making a JPY rally more likely if market sentiment changes.

Risks for USD/JPY

Risks for USD/JPY include expected Fed rate cuts, with HSBC forecasting one for September, alongside possible global economic downturns or significant slowdowns in the US. Questions about the Fed’s independence may also weigh on the currency pair. HSBC notes that the Ministry of Finance may intervene if USD/JPY reaches 155–160, a point that could change due to US focus on currency intervention. While HSBC sees the fair value for USD/JPY within its current range, potential events in trade diplomacy, Fed actions, and MoF interventions pose risks for the pair. Further appreciation is possible, but existing policies and valuation limitations might act as barriers. Currently, the USD/JPY pair is trading above the recommended 146–152 fair value range, recently reaching over 158. This raises concerns as it approaches the potential intervention level of 160. Current price levels reflect a notable tension between US interest rate expectations and the risk of action from Japanese authorities.

Market Dynamics and Strategies

We should keep an eye out for a significant drop fueled by intervention, similar to the move in October 2022 when over $40 billion was spent to defend the yen after it crossed 151. Japan’s top currency diplomat, Masato Kanda, recently emphasized that authorities are ready to act at any time, which adds weight to this warning. The market remembers the past rapid drop of the yen, leading traders to anticipate a similar occurrence. The triggers for a reversal are becoming more clear, especially regarding future central bank policies. The CME FedWatch Tool indicates that there is now a greater than 60% chance of a US rate cut by September. A move towards easing by the Fed would reduce the interest rate gap that has strongly supported the pair’s strength. From a fundamental standpoint, the yen’s weakness is at an all-time low, which is significant. The yen’s real effective exchange rate, a comprehensive measure of its value, recently hit its lowest level since the 1970s. This level of undervaluation strongly supports the case for a potential long-term recovery, regardless of short-term policy actions. Given this analysis, we believe that derivative strategies that benefit from volatility spikes are wise. Buying options like straddles or strangles allows traders to profit from large price movements in either direction without needing to predict the exact timing of an intervention or breakout. Alternatively, traders convinced that intervention is close could buy JPY calls (USD/JPY puts) to prepare for a sharp decline, even though higher implied volatility makes these options costlier. Create your live VT Markets account and start trading now.

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