Currency analysts at MUFG note that there has been a significant change in market positioning ahead of the latest Bank of Japan (BoJ) meeting, which will limit further buying opportunities for the yen in any further policy change.

There will also be corrective pressure after the dollar/yen (USD/JPY) exchange rate has fallen more than 15% since its October peak.

The Bank still expects domestic and global pressures to further strengthen the yen over the next few months. The bank adds: “Nevertheless, the downward movement suggests that a full reversal of the 2022 move is possible this year, meaning levels below 120.00 are likely later this year.”

The USD/JPY pair was trading around 128.40 on Monday from 7-month lows at 127.25 in Asian trading.

Pressure on further Bank of Japan policy adjustment

The Bank of Japan announced a change in monetary policy at its December meeting with a change in yield curve control (YCC) to allow a ceiling of 0.50% for the 10-year yield from 0.25% previously.

Japanese yields rose after the move and the yen jumped in currency markets, rising more than 5% against the dollar.

MUFG says the December move was insufficient to ease bond market pressures and traders expect the bank will have to change policy more significantly.

The bank adds: “The dysfunctional aspects of the JGB market were not addressed by the YCC changes in December, meaning there are now credibility issues with the Bank of Japan that need to be addressed.”

This week’s meeting will be the penultimate for current Bank Governor Kuroda, which has increased speculation of a policy change.

MUFG also notes that the new BoJ governor is due to take office in early April, with the first policy meeting on April 28. It is logical to assume that policy changes will take effect once the new governor takes office, but MUFG believes there will be pressure to remove uncertainty ahead of the changes.

Three policy options are possible at this week’s meeting, according to MUFG.

The Bank could leave policy unchanged and try to curb market speculation.

Second, it could widen the range further by setting a new ceiling on the 10-year rate yield at 0.75% or 1.00%.

Third, the bank could relinquish yield control altogether, and intervene to smooth out the sharp rise in yields.

MUFG is looking at the potential reaction of the yen and the possibility of another 5% jump in the yen.

According to the bank, “This is certainly a possibility, although the December change opened up much more speculation ahead of this week’s meeting, and in that sense it is clear that there is already long positioning in anticipation of a change, which could mean we see a more subdued USD/JPY decline this time around.”

Other factors are also supportive of the yen

MUFG also believes there are other reasons for the yen to strengthen over the next few months.

There are strong expectations that US inflation has peaked and the yen is inclined to strengthen amid hopes of a change in the Federal Reserve’s stance towards a less aggressive policy stance.

According to MUFG, “fundamental factors are in favor of further weakening of the U.S. dollar.”

The bank also notes that energy prices have fallen, which will limit Japanese imports and help support the trade account.

The bank notes: “Certainly, the terms-of-trade shock will not be repeated in 2022, which adds another dimension to the yen’s strength.”