After posting three-week-plus highs just shy of Y112.00 in Asian action Monday, market players were quick to take profit on existing dollar-yen long positions, with event-risk seen in the form of this week's Federal Reserve and Bank of Japan meetings.
The same held true for the Nikkei 225, which rose to a two-and-a-half-month high of 17,613.56 overnight and then backed off.
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Wednesday's Fed decision, on the surface, was not expected to roil, in that the central bank was widely expected to keep policy steady.
Nevertheless, any change in the accompanying statement, whether deemed dovish or hawkish, has the potential to lead U.S. Treasury yields lower or higher, with spillover effects for dollar-yen.
"The Fed's messaging will be key," said MNI Fed watcher Steve Beckner in an analysis piece Monday.
"The meeting presents Chair Janet Yellen and her colleagues with an opportunity, should they choose to seize it, to lay the groundwork for another modest rate hike in coming months," he said.
On Dec. 16, the central bank raised the fed funds rate by 25 basis points, after seven years of being near zero. Since then, market players have vigorously debated when the next rate hike comes.
The FOMC "could take a first tentative step toward a second rate hike by rhetorically giving itself latitude to move as soon as its June 14-15 meeting," Beckner said. See MNI Main Wire story at 11:20 a.m. ET.
Even if dollar-yen emerges unscathed from the Fed decision, market players will be reluctant to dive into a yen position so close to the BOJ decision only one day later.
A MNI BOJ Insight piece, released Monday, noted that ahead of the two-day meeting April 27-28, BOJ officials fret that they may need to once again push back the timing of meeting their 2% inflation target and add more easing to ensure the economy stays on track.
In terms of other easing measures, some officials feel the negative interest rate policy (QQENIRP announced in January pleased initially, but roiled later) is unpopular with consumers and commercial banks, and thus it may not be the first choice if the board decides to ease this week.
Among possible policy options is to increase the purchases of Japanese government bonds from the current pace of about Y80 trillion annually and/or buy more exchange traded funds or ETFs.
If the BOJ board decides to cut the negative interest rate further from the current minus 0.1%, it would also consider other policy measures, such as applying the negative interest rate not only to a small portion of excess cash parked by lenders at the central bank but also to the interest the BOJ charges on loans to banks. See MNI Main Wire at 7:16 a.m. ET for details.
In terms of possible BOJ easing action this week, there are mixed views about what the central bank might announced.
Capital Economics Japan Economist Marcel Thieliant looked for the BOJ to lower the growth forecast for FY 2016 from 1.5% to 1.3% and to keep the first half of FY2017 as the timeframe for hitting the 2% inflation target.
The BOJ may also increase the annual pace of monetary base expansion to Y90 trillion from Y80 trillion, with a breakdown of Y5 trillion in Japanese government bonds and Y5 trillion in equity linked ETS, and announce another cut in the interest on excess reserves rate to -0.3% from -0.1%, he said.
"If the Bank does ease, we should therefore still expect a renewed weakening of the yen and a rise in the Nikkei," Thieliant said.
"Our end-2016 forecasts for yen/dollar and the Nikkei are Y120 and 19,500," he said.
RBS senior market strategist Mansoor Mohi-uddin reminded that the first two rounds of increased bond purchases by the BOJ, in April 2013 and October 2013, led to sizable rallies in dollar-yen and Japanese equities.
This year, however, "the poorly communicated introduction of QQE with a Negative Interest Rate in January led to dollar-yen falling 10%," Mohi-uddin said.
"To show it hasn't run out of policy options," RBS expected the BOJ to announce "three key changes" this week.
RBS looked for the BOJ to raise JGB purchases to Y100 trillion from Y80 trillion, to double ETF purchases to Y6 trillion from Y3 trillion a year, and to cut the -0.10% policy rate on excess reserves by "at least 15 bps" and "follow the ECB by lending funds at its new negative rates," Mohi-uddin said.
The market was uncertain about whether the central bank will act at all.
Two-week risk reversal in the FX markets has corrected drastically ahead of this week's BoJ meeting "as the market's expectation for BoJ's action has risen to all time-high, but one-month risk reversal has not reacted as much," said strategists at BOA Merrill Lynch.
"This reflects (1) growing expectations of BoJ's action; (2) expectation for decent short-term impacts from potential easing due to lower USD/JPY level and JPY long positions; and (3) expectation for limited medium-term impacts on the other hand," they said, adding that "this is largely consistent with our own views."
BOAML saw a "significant chance" that the BOJ will wait until June, which would be ahead of July Upper House elections but after the May fiscal package.
However, the central bank could expand QQE in either April or June, they said
The strategist expected the BOJ to expand ETF purchases to Y6 trillion from Y3 trillion and looked a "small further move into negative rates."
BOA Merrill stressed that this "should not be the main policy change given the risk of another adverse market response."
As for FX response, dollar-yen will take its cue from risk sentiment and U.S. Treasury yields, they said.
"U.S. interest rates have not risen commensurately with the recovery of risk assets, suggesting this risk rally may have been backed more by assumptions of Fed dovishness than materially better global economic outlook," the strategists said.
"This matters to JPY, which is the world's primary funding currency; USD/JPY is still likely to test Y100-Y105 this year, in our view," BOA Merrill said.
Dollar-yen was trading at Y111.22 Monday afternoon, in the middle of a Y110.84 to Y111.91 range.
This month, after posting a high of Y112.58 April 1, the first trading day of the new fiscal year, the pair made what could be viewed as a double-bottom, hitting a low of Y107.67 April 7 and Y107.63 April 11.
Last week, the pair rose from lows near Y107.77 on April 18 to post a high of Y111.81 April 22. Today saw only a modest extension.
The 55-day moving average comes in at Y112.02 and may act as larger resistance in the near-term.
Dollar-yen last closed above the 55-day moving average in late January/early February and then for only a few days.
From the 2016 high of Y121.69, seen Jan. 29 the day the BOJ announced QQE NIRP, to the 2016 low of Y107.63, seen April 11, the yen has risen by 11.6%.
CFTC data released Friday, for positions as per April 19, showed that speculative accounts had a record net yen long position of 71,870 contracts. While a 100,000 contract size is typically needed to be deemed extended, for yen this is a sizable position.
Dollar-yen closed at Y109.21 on April 19 and in light of the run-up to today's highs just shy of Y112.00, these speculative positions have likely been pared back sharply.
The Nikkei 225 closed down 0.76% at 17,439.30 Monday, after trading in a 17,403.87 to 17,613.56 range, with the earlier high the highest since Feb. 2, when prices peaked at 17,864.70.
A decisive break above 17,905.37, the Feb. 1 high, would target the psychological 18,000 mark.
A clear-cut move above the 200-day moving average, currently at 18,726.28, would target the 2016 high of 18,951.12, seen Jan. 4.