06:54 AM EDT, 09/03/2024 (MT Newswires) -- The yen (JPY) has strengthened during the Asian trading session Tuesday amidst more risk-off trading conditions, said MUFG.

Yen strength has been most evident against the G10 commodity currencies of the Australian (AUD) and New Zealand (NZD) dollars with AUD/JPY and NZD/JPY both falling by around 1% overnight Monday, wrote the bank in a note to clients. MUFG Monday raised its outlook for the yen to show further gains in the year ahead.

In the bank's updated forecasts, USD/JPY is expected to fall towards 137.00 by the middle of next year. The case for further yen strength is supported by MUFG's expectation that the Bank of Japan (BoJ) will continue to tighten monetary.

Recent comments from Governor Kazuo Ueda have supported the bank's view that the BoJ will hike rates again at the December policy meeting if Japan's economy progresses in line with BoJ's outlook and financial market conditions continue to stabilize after the bout of volatility in early August. MUFG expects political uncertainty ahead of the upcoming LDP leadership election and the possibility of an early parliamentary election will prevent an even earlier rate hike in the fall.

At the same time, the United States Federal Reserve has signaled strongly that it plans to begin cutting rates later this month. The release on Friday of the latest US nonfarm payrolls (NFP) report for August will be important in determining whether the Fed begins with a normal 25bps rate cut or delivers a larger 50bps cut to reflect more concern that it has fallen behind the curve in easing policy, pointed out the bank. The August NFP report would have to reveal evidence of a sharper slowdown in employment growth to trigger a larger rate cut even after the significant downward revisions to employment growth over the past year.

The US rate market is currently pricing in around 33bps of cuts ahead of the September FOMC meeting highlighting that a 25bps is judged as the most likely outcome. It leaves the US dollar (USD) vulnerable to a further sell-off if the NFP report proves significantly weaker than expected on Friday, according to the bank.

The yen has also been supported overnight by more risk-off trading conditions which has weighed on the G10 commodity currencies of the Australian and New Zealand dollars, added MUFG. Economic data releases at the start of this week have highlighted China's economy is still struggling and will require further policy stimulus to meet the government's gross domestic product (GDP) target for this year of around 5%.

The composite PMI survey for August weakened for the fifth consecutive month and fell to its lowest level since the end of 2022. It will keep pressure on China's central bank (PBoC) to lower rates further. In these circumstances, MUFG isn't convinced that the recent strengthening of the renminbi (CNY) against the US dollar will be sustained.

The bank is forecasting a more modest drop for USD/CNY to 7.0500 by year-end after the pair has already fallen from around 7.2500 to 7.1000 since July.