Yen crumbles under towering dollar and US Treasury yields

The Japanese yen experienced significant weakness against the US dollar towards the end of last week, with the USD/JPY exchange rate reaching a 34-year high of around 115.75. This marked a continuation of the downward trend that began in late 2021, as investors continued to sell the yen in favor of the stronger US currency.

Several factors contributed to this trend. One of the primary drivers was the widening interest rate differential between Japan and the United States. The Bank of Japan (BoJ) has maintained its ultra-loose monetary policy, keeping its benchmark interest rate at -0.1%, while the Federal Reserve (Fed) has signaled its intention to raise rates multiple times this year in response to rising inflation.

Another factor that weighed on the yen was the surge in US Treasury yields. The yield on the benchmark 10-year US Treasury note reached a high of 2.11% in late March, its highest level since May 2019. This yield increase made Japanese government bonds (JGBs) less attractive compared to their US counterparts, further encouraging capital outflows from Japan and putting downward pressure on the yen.

Traders had initially expected the Fed to implement a more aggressive monetary tightening cycle this year, which would have further widened the interest rate differential between the two countries and potentially pushed the USD/JPY exchange rate even higher. However, recent economic data releases and comments from Fed officials have led investors to scale back their expectations for the number of rate hikes in 2022.

As of March 25, 2022, CME Group's FedWatch Tool indicated that markets now anticipate a total of four 25 basis point rate hikes by the end of the year, down from an earlier expectation of six hikes. This shift in market sentiment helped to ease some of the pressure on the yen, although it remained underperforming against the dollar overall.

In summary, the Japanese yen faced significant challenges towards the end of March 2022 as the US dollar strengthened against it due to a combination of factors, including a widening interest rate differential and rising US Treasury yields. While expectations for aggressive Fed rate hikes had initially contributed to the yen's weakness, recent developments have led investors to scale back their expectations, providing some relief for the beleaguered currency. However, the long-term outlook for the yen remains uncertain as the BoJ's accommodative monetary policy continues to put downward pressure on its value against the dollar.