2017 USD/JPY Annual Forecast

The USD/JPY had a tumultuous year in 2016, led to the downside by a stronger Japanese Yen due to ineffective Bank of Japan policies and to the upside by the threat of inflation in the U.S. and the delivery of higher interest rates from the U.S. Federal Reserve.

Essentially, the direction of the Forex pair was dictated by a dovish BOJ and a hawkish Fed.

2016 Market Forces

The USD/JPY began the year at 120.111 and proceeded to rally to 121.678 by January 29 on the heels of a hawkish Fed at the end of 2015. In late 2015, the Fed raised its benchmark interest rate by 25 basis points and projected it would deliver as many as four rate hikes in 2016.

However, at the first Fed monetary policy meeting in late January 2015, Fed Chair Janet Yellen was already signaling to investors that she and the Fed were not prepared to raise rates because of excessive market volatility and the possibility of a weaker U.S. labor market. Additionally, stubbornly low inflation remained under the central bank’s target of 2.0%.

The Fed continued to deliver a dovish tone throughout the Spring when it became clear to investors that the central bank would not likely raise rates until after the U.S. elections in November. The Dollar/Yen reached its low for the year on June 24 at 98.887, the same day the U.K. voted to leave the European Union, in a move that became known as Brexit.

From there, the USD/JPY proceeded to become range bound as global equity markets stabilized following a sharp sell-off that culminated with Brexit. With the worst apparently over, at least temporarily, demand for higher risk assets increased, putting pressure on the lower-yielding Japanese Yen.

The Dollar/Yen remained rangebound until early November when Donald Trump surprisingly won the U.S. Presidential election. From November 9 to December 15, the USD/JPY surged from 101.179 to 118.658 as investors bet that Trump’s policies would cause a resurgence in inflation. This helped drive up U.S. Treasury yields and stocks, making the U.S. Dollar a more desirable assets.

In December, the Fed raised rates 25 basis points and projected at least three rate hikes in 2017. The USD/JPY closed the year at 116.979, down 3.312 or -2.61%, but with enough upside momentum to carry over into 2017.

Bank of Japan Moves in 2016

From the Bank of Japan’s perspective, it liked the move at the end of the year since its policies throughout the year were generally useless at helping to boost the economy or weaken the Yen.

As far as the BoJ’s time table is concerned, on January 29, the USD/JPY topped after the central bank announced it was imposing a negative interest rate for the first time in an effort to jumpstart the Japanese economy out of years of stagnation.

On March 15, the BoJ left its major monetary policies unchanged but downgraded its view of the economy, opening the door to further action down the road.

On April 28, the Yen surged more than 3% against the U.S. Dollar after the BoJ stuck to its current package of policies aimed at stoking economic growth and inflation. The BoJ’s inaction defied market expectations that the central bank would take further steps to stimulate the economy.

The Japanese Yen spiked higher again on June 16 after the Bank of Japan refrained from offering additional monetary stimulus despite anemic inflation and weak global growth. This news sent the Yen spiking to a two-year high.

In late July, the BoJ once again disappointed investors by offering a moderate easing when many expected a more aggressive stimulus package.

Once again on September 21, the Bank of Japan surprised traders when it announced it was targeting a zero interest rate on its 10-year government bonds. The central bank called it a “new framework” because it hadn’t previously targeted a rate for the 10-year bond. Some found this news to be encouraging, but others wanted to see new direct stimulus measures.

On November 1, the central bank opted to leave policy unchanged, despite sharply cutting its inflation forecasts. It now forecasts that its annual inflation rate will reach 2% around fiscal 2018, which ends in March 2019, instead of fiscal 2017.

At its last meeting in 2016 and its first since Trump’s win drove the Dollar sharply higher against the Japanese Yen, the BoJ did nothing and said it will maintain policy as long as it is necessary to achieve and maintain the bank’s 2% price stability target in a stable manner.

2017 Forecast

At its last meeting the Bank of Japan upgraded its assessment of the economy, noting that a “moderate recovery trend had continued” while exports “picked up”. It also said that it expects the moderate recovery to turn into a modest expansion in the period ahead.

This is great news, however, the credit for the economy’s turnaround should go to Trump and the Fed.

With the BoJ expected to stand pat on policy for most of 2017 and the Fed likely to raise rates again, the interest rate differential should continue to favor the U.S. Dollar over the Japanese Yen in 2017.

The BoJ will face a decision, however, if rising global interest rates start to move Japanese Government Bond rates higher. This is because of the bank’s decision in September to target a zero interest rate on its 10-year government bonds.

I expect to see the USD/JPY continue to climb in 2017 if Trump’s policies drive up inflation as expected and the Fed chases inflation with at least three rate hikes. However, the Japanese Yen may at times pick up strength if the U.S. economy falters especially the labor market. Of course, the failure to create enough inflation to satisfy the Fed’s 2.0% mandate could also weaken the U.S. Dollar against the Yen.