USD/JPY Forecast Shows Potential for Continued Decline Amid Changing Market Dynamics

Over the past four weeks, the USD/JPY has seen a significant decline. Citi Research suggests that the pair is susceptible to further selling pressure over time.

As of 08:55 ET (12:55 GMT), the USD/JPY traded 1.8% higher at ¥146.88. This bounce came after Bank of Japan (BOJ) officials tempered expectations of additional interest rate hikes earlier on Wednesday. BOJ Deputy Governor Shinichi Uchida stated that the bank will avoid hiking interest rates during periods of market instability, following recent volatile movements in the Japanese yen.

Despite this, the yen remains well above its 38-year lows reached earlier this year. The pair has dropped sharply from a high of nearly ¥162 last month.

The yen’s recent weakness is primarily due to Japan’s record-low interest rates, which have fueled the popular yen carry trade. This trade involves borrowing yen and using it to buy higher-yielding currencies. As a result, the yen has been a favored funding currency for carry trades involving U.S. dollars, Mexican pesos, New Zealand dollars, and others.

The viability of the yen carry trade came into question when Japanese authorities began intervening to support their currency. The trade further unraveled when the BOJ hiked interest rates last week. Currently, Japan’s overnight rate stands at just 0.25%, while U.S. dollar rates are around 5.5%. However, carry trades are more influenced by currency moves and rate expectations than the actual level of interest rates.

Citi Research analysts noted in an August 7 report that the interest rate spread and risk-reward balance for the JPY carry trade have not yet met conditions that previously led to a USD/JPY downtrend. However, Japanese government intervention to buy yen since 2022 has altered the underlying supply and demand dynamics, potentially accelerating the peak for the USD/JPY. Consequently, the pair may not return to its high of last month and could be increasingly vulnerable to downside pressure over time.

Citi Research forecasts the USD/JPY to decline below ¥140 in 2025, ¥130 in 2026, and ¥120 in 2027.

Stay updated with the latest forex news and analysis on our website for more insights into currency trends and trading strategies.