Japanese Yen underperforms peers despite post-election US Dollar sell-off

• USD/JPY trims a part of earlier losses as the Japanese Yen struggles to benefit from broad US Dollar weakness.
• US midterm results push the US Dollar to five-week lows.
• Wide interest rate differentials limit the Yen’s gains despite the BoJ’s hawkish stance.

USD/JPY trades with a negative bias on Wednesday as the US Dollar (USD) slides to five-week lows following the US midterm election results. However, the Japanese Yen (JPY) struggles to capitalize on the Greenback’s weakness, trimming a large part of its earlier gains while underperforming most major peers.

At the time of writing, USD/JPY trades around 158.32, down 0.25% on the day, after reaching an intraday low of 157.39.

The US Dollar came under pressure as Democrats’ victory in both houses of Congress sets the stage for a divided government, raising the risk of political gridlock in Washington and adding uncertainty over fiscal policy. The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, trades around 101.40, down 0.44% on the day and near five-week lows.

Analysts at MUFG/BTMU argue that the recent US mid-term election outcome 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.” They note that the latest bout of Yen strength offers only limited relief, stressing 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.”

The interest rate gap between Japan and other major economies remains wide, with the Bank of Japan’s (BoJ) policy rate at 1.25%. While the BoJ is tightening gradually, inflation pressures from the Middle East energy shock have prompted other major central banks to raise interest rates, with further hikes also expected.

As a result, the BoJ’s hawkish stance offers limited support to the Yen, as interest rate differentials are expected to remain wide, leaving the currency at a yield disadvantage. Nevertheless, intervention warnings from Japanese officials keep traders cautious about betting against the Yen. Finance Minister Satsuki Katayama said on Monday that Japan would act against disorderly or excessively speculative currency moves.

MUFG/BTMU point out that “intervention in last July / early August has distorted the link with rates,” but add that the currency’s behaviour continues to highlight deeper forces at work: “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.” Even so, they remain cautiously optimistic on the medium-term outlook, stating that “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.”