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Domestic politics lit the fuse for USD/JPY’s breakout. Global growth fears may extinguish it. With curves flattening and positioning stretched, downside risks are building.
- BOJ rate hike expectations remain intact
- AI-led job cuts revive fears seen earlier this week
- US curve bull flattens as economic growth expectations fall
- DM curves hint at global growth concerns
- Narrowing yield differentials threaten yen-funded carry
Summary
USD/JPY’s breakout earlier this week was driven by domestic noise around the BOJ. That move is already fading as global growth concerns gather pace. With AI optimism facing fresh scrutiny and developed market bond curves flashing warning signals, the backdrop for carry trades looks increasingly fragile. If bond markets are right, downside risks for yen pairs may be building, perhaps substantially so.
Political Squeeze Fades
USD/JPY broke higher earlier this week on a torrent of domestic headlines. Reports that Prime Minister Sanae Takaichi had urged BOJ Governor Ueda to hold off on further rate hikes, followed by her nomination of two perceived reflationists to the BOJ board, saw markets question how far and how fast the Bank of Japan would continue normalising policy. The result was a squeeze higher in the pair.
However, that move is now starting to unwind. Ueda’s acknowledgement on Thursday that the Bank is still considering whether to raise rates as soon as March or April, combined with a slightly hotter-than-expected Tokyo core-core CPI print earlier today, has shifted the tone and kept tightening expectations alive.
Source: Bloomberg
From Productivity Boom to Job Cuts
But the more important development may lie outside Japan. The global backdrop is starting to look less supportive for carry trades and elevated asset prices. If the signals emerging from bond markets continue to point to slowing nominal growth, the domestic drivers that sparked the breakout risk being overwhelmed, tilting directional risks for USD/JPY lower.
Part of that shift is narrative.
Overnight, Block announced plans to cut more than 4,000 jobs, explicitly linking the decision to AI-driven efficiency gains. Investors rewarded the move with its share price surging after hours, providing an incentive for other companies to do the same. But the signal is uncomfortable. What was framed as an AI-led productivity boom is increasingly being translated into workforce reductions and margin expansion.
Earlier in the week, research from Citrini warned that AI optimism may be overstating the near-term growth impulse while understating the potential drag from labour displacement. That thesis is now being given oxygen. The idea that AI may ultimately weigh on income growth and demand, rather than simply boost productivity, is moving closer to the mainstream.
The bond market appears to be taking notice.
Bonds Warn on Growth Outlook
Source: TradingView
US Treasury yields have fallen across the curve, with a clear bull flattening as longer-dated yields compress. That is a classic signal of moderating nominal growth expectations. The market is clearly questioning the durability of the US growth impulse that underpinned higher yields, strong risk appetite and a firmer dollar earlier in the year.
Importantly, this is not confined to the United States. Developed market curves are flattening more broadly. While the mechanics differ across jurisdictions, the common thread is a rapid reduction in growth expectations. That suggests something more systemic than a US-specific repricing.
Source: TradingView
Carry Trades Priced for Perfection
This is where the problem emerges for the yen and carry trades.
If yield differentials between Japan and the rest of the developed world begin to narrow, the risk of yen strength increases. That alone raises the holding cost of yen-funded carry positions.
But there is a second layer of vulnerability.
Technology has led the rally in broader risk assets for years. Yet momentum there is stalling. Even blowout results from Nvidia (NASDAQ:NVDA) earlier this week failed to generate sustained gains, with the AI poster child sold aggressively post earnings. Leadership is no longer clean.
In response, cyclical assets have stepped in. European and Asian equity markets, outside of China, have surged to record highs as investors rotated into regions previously shunned in favour of the United States. That rotation has helped fuel mammoth bullish trends in yen crosses, as capital chased opportunities in markets perceived to offer catch-up growth opportunities.
The question is whether that outperformance can persist if the bond market is right.
If curves are flattening because nominal growth expectations are being marked lower, the backdrop for cyclicals becomes far less supportive. Stronger global growth is the oxygen for those trades. If that oxygen thins, the rationale erodes rapidly.
For now, this may still be narrative-driven. But if the bond market is signalling something more substantive about the global outlook, downside risks for yen pairs and risk-sensitive assets tied to the global cycle may be building, potentially substantially given how far some of these trades have run.
The near-term test for this thesis may arrive quickly. Next week brings a raft of US labour market data, headlined by February US nonfarm payrolls. If the bond market is correctly anticipating a moderation in growth, the jobs data will either validate that signal or force a rethink.
Against that backdrop, is this really the environment to be charging into fresh yen shorts, given how far some crosses have already run and how sensitive positioning may be to disappointment?
USD/JPY Breakout Falters
Source: TradingView
On the 4H chart, the breakout earlier this week stalled at 156.83, with the price setting a lower high on Thursday before easing lower again in Asia today. The pattern resembles a head and shoulders, but with no meaningful follow-through despite a break of the neckline, the reliability of the signal must be questioned.
On the downside, there have been multiple tests of the 155.65 area, with the only sustained break beneath stalling at 155.35 before reversing. Those are the immediate levels to watch, along with the intersection of the February 17 uptrend and the January 23 downtrend located between them. A breach of that zone would open the door to a deeper flush, with 155 and 154 the next reference points.
Should the heaviness dissipate, which could easily occur given its month-end where flows rather than fundamentals often drive price action, the 50DMA sits near 156. The 156.50 area has also attracted interest in recent sessions before 156.83 comes back into focus.
The oscillators mirror the soggy price action, with RSI (14) setting lower highs and now hovering just above the neutral 50 level, while MACD has crossed below the signal line and is trending lower, albeit still in positive territory. Upside momentum is fading, but the bears do not have control yet.