Japanese Yen: JGB spillover supports firmer JPY against US Dollar – OCBC

OCBC analysts Sim Moh Siong and Christopher Wong note that soaring Japanese government bond yields, especially at the long-end, are playing a pivotal role in bolstering the Japanese Yen's value against the US Dollar. The market now believes there is a high likelihood of a Bank of Japan (BoJ) rate increase in September, as reflected in the rising global curves.

However, the policymakers' willingness to continue tightening monetary policy remains uncertain. The strategists have kept their USD/JPY target for end-2026 at 163, but they will only become more optimistic if the BoJ indicates a more aggressive rate hiking trajectory. The rise in long-end yields, particularly in the US, is a result of higher real yields driven by persistent fiscal deficits and increasing corporate financing needs due to AI.

Yet, this cannot be considered the sole reason behind the JPY's strengthening. The spillover effect from the rising Japanese government bond yields should not be underestimated. Despite coordinated Japan-US FX interventions and growing discussions about a faster pace of BoJ rate hikes, concerns over JPY weakness and the perception that the BoJ is lagging have not been fully addressed.

With a rising probability of a September BoJ rate hike, traders are pricing it in, with the odds increasing to approximately 80% from 50% at the start of August. If the BoJ accelerates its policy normalization and the JPY is no longer viewed as a low-yielding funding currency, the currency is expected to strengthen over time. Quarterly rate hikes through 2027 could be a significant driver for more sustained JPY appreciation.

However, the extent of policymakers' appetite for further tightening beyond September or October remains unclear. Despite this, the analysts maintain their end-2026 USD/JPY target of 163, but could turn more favorable on the JPY if the BoJ signals a more aggressive rate hiking approach or if Japan actively encourages capital repatriation, including through institutions like the Government Pension Investment Fund (GPIF).