The Japanese Yen (JPY) has taken a relatively defensive stance ahead of tomorrow’s LDP leadership vote. Even though BoJ commentary is clearly pointing toward further tightening – reinforced by Governor Ueda overnight – much of the shift in policy differentials between the BoJ and the Fed, in addition to between Japan and other countries, was well reflected in flows in the first half of September, BNY's Head of Markets Macro Strategy Bob Savage reports.

Fiscal outlook key risk for Yen trajectory

"The market view that there would be another opportunity to realize JPY valuations has contributed to the JPY retaining a solid holdings position. However, should the next administration adopt a more expansionary fiscal tone, it would be difficult to dismiss the impact on policy execution."

"Even before the election was called, the BoJ had been adjusting quantitative tightening operations to limit the impact on market functioning and the curve – a step recently emulated by the Bank of England. Should fiscal impulse strengthen beyond current expectations, especially with inflation running ahead of target, further mitigation through policy adjustments will be necessary and this could impact the trajectory of real rates."

"The knock-on effect on the JPY would be obvious, though for now it appears that much of the selling is being undertaken through USD/JPY purchases. Even if the status quo generally prevails, iFlow’s JPY holdings figure indicates it could be difficult to add to JPY longs aggressively from current levels, notwithstanding ongoing valuation attractions."