Why is the Japanese Yen trailing peers despite the post-election US Dollar sell-off?

• USD/JPY recoups some earlier losses, with the Japanese Yen unable to draw much support from widespread US Dollar weakness.
• The US Dollar falls to five-week lows following the US midterm election outcome.
• Despite the BoJ’s hawkish position, sizeable interest rate gaps cap the Yen’s advance.

The Japanese Yen (JPY) has surrendered much of its earlier advance and trails most major peers, failing to take full advantage of a weaker US Dollar (USD). Even so, USD/JPY remains under pressure on Wednesday, with the Greenback falling to five-week lows after the US midterm election results.

Having touched an intraday low of 157.39, USD/JPY is trading near 158.32 at the time of writing, a decline of 0.25% for the day.

A Democratic victory in both houses of Congress has weighed on the US Dollar by paving the way for a divided government. The outcome heightens the risk of a political impasse in Washington and creates further uncertainty around fiscal policy. Meanwhile, the US Dollar Index (DXY), a measure of the Greenback against a basket of six major currencies, is hovering near five-week lows at around 101.40, lower by 0.44% on the day.

In the assessment of MUFG/BTMU analysts, the latest US midterm election result is “unlikely to impact the US-Japan relationship and the strong message emanating from Washington over its opposition to the continued weakness of the yen.” The analysts see little respite in the Yen’s recent appreciation, emphasising that “the reprieve for the yen is marginal (today’s gain is USD-related) with the rates/FX link for the yen still relatively weak.”

With the Bank of Japan’s (BoJ) policy rate at 1.25%, Japan continues to face a sizeable interest rate gap with other major economies. The BoJ is pursuing gradual tightening, but inflationary pressures arising from the Middle East energy shock have led other major central banks to increase rates, with additional hikes expected.

Expectations that these rate differentials will stay wide leave the Yen at a yield disadvantage, limiting the support available from the BoJ’s hawkish position. However, warnings of intervention by Japanese officials are making traders wary of taking positions against the currency. On Monday, Finance Minister Satsuki Katayama said Japan would take action against disorderly or excessively speculative currency movements.

According to MUFG/BTMU, “intervention in last July / early August has distorted the link with rates,” although the Yen’s performance still points to underlying forces: “what the movement of the yen does indicate is that there are still some structural flows that continue to weigh on yen performance and those flows could well be slow to change.” Their medium-term view nevertheless retains a degree of optimism: “we still suspect the yen is close to a turning point and market rates and/or policies by the government to encourage greater sums of capital to remain in Japan should have a positive impact on the yen.”