As expectations for tax cuts rise this week, the yen is taking the news in stride. Previously, we had argued that the yen was set to weaken given strength in crude oil and potential US tax cuts. In an environment where GDP growth is strengthening, an upturn in inflation expectations usually leads to a stronger US dollar (as markets price in additional rate hikes). As both rising crude oil and tax cuts raise inflation expectations, our view was that the yen should fall in relative terms. An overview of USD/JPY is shown below for reference:

Weak trend, and not much momentum

Source: TradingView.com, MarketsNow

The last time the yen sold off sharply was following Trump’s victory in the US presidential elections (stronger USD/JPY implies yen weakness). At the time, US growth and inflation expectations shot up as markets priced in Donald Trump’s pro-growth agenda coupled with a Republican sweep of both houses of Congress.

Recent events fail to excite the yen

This time, reactions in the yen have been fairly modest. The yen began weakening in October after the US Senate passed the 2018 government budget (allowing tax reforms to pass without a Democrat filibuster). As hopes for tax reforms rose and crude oil kept rallying, the yen seemed destined to keep weakening.

In November, the yen strengthened following developments in Special Counsel Robert Mueller’s investigations. According to news reports, his investigations suggested that Trump had colluded with the Russian government as a candidate – an impeachable offense. While fears of ‘Russia-gate’ have since proven unfounded, tax reforms have become far more likely to get through Congress. Despite better political news from Washington, the yen has only modestly weakened. The ongoing rally in crude oil has also had a limited impact on the currency. While WTI crude has strengthened to $59 per barrel, markets have discounted today’s high crude oil prices as transitory in nature. As the current bearish trend in the yen runs out of steam, the odds of a significant sell-off from here seem remote.