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  • USD/JPY has rallied on Thursday as the nominal yield differential between US and Japanese government debt widens.
  • The pair has stopped short of hitting the 104.00 level, but still hit multi-week highs.

USD/JPY is consolidating below the 104.00 level as US dollar bulls take a breather after the pair hit its highest levels in four weeks. At present, the pair trades with gains of around 80 pips or 0.8% on the day and JPY is the worst performing G10 currency.

The broadly risk-on vibe of the market on Thursday is one reason why JPY has been performing so poorly and likely explains why the next worst performing G10 currency is fellow safe-haven CHF. At present, US stock markets are surging (the S&P 500 crossed above 3800 for the first time and is up 1.3% on the day and the Nasdaq 100 has recovered Wednesday’s losses) and US bond yields are higher as markets price in further government borrowing under a Democrat-controlled Congress which is expected to deliver stronger growth in 2021.

Widening US/Japan rate differential hurting the yen

More than just the market’s risk-on vibe reducing the demand for the safe-haven yen, the focus is also on the fact that the (nominal) yield advantage of investing in US government debt over Japanese government debt continues to widen significantly as US markets price in 1) a greater supply of US government debt that pushes yields higher and 2) higher inflation expectations that all this additional stimulus creates, that also pushes nominal bond yields higher.

At the start of the week, the yield on the Japanese 10-year was around 0.02% and has since barely risen to about 0.35%. As ever, the BoJ policy to keep the 10-year yield close to zero is preventing significant upside. Over the same time period, the US 10-year yield has surged from just above 0.9% to current levels around 1.08%, widening the US/Japanese 10-year yield spread by nearly 15bps.

If this spread continues to widen, then further USD/JPY upside could well be in store. However, if this widening is purely being driven by higher inflation expectations in the US, as opposed to an increase in real US yields, then its bullish implications for USD/JPY may be lessened.

USD/JPY at multi-week highs