Bank of America (BofA) suggests that while the USD/JPY now has an annualized carry of more than 5%, carry trade demand for this pair has been more muted due to uncertainty with the Bank of Japan's monetary policy.

Analysing the USD/JPY spot vs the 2-year US-JP rate differential since June 2021, when the Fed turned more hawkish, suggests the yen is fairly valued. BofA maintains a bearish view on the yen against the USD for the remainder of 2023, expecting the carry factor to weigh against the yen as long as the Fed maintains its hawkish guidance and keeps the federal funds rate at the current level.

The bank anticipates a more substantial yen rally to take place in 2024, given its prediction that the first Fed rate cut will happen in Q1 2024. Their official forecast is for the USD/JPY to rise to 140 by the end of 2023, before falling to 125 by the end of 2024.

However, they warn that their bearish yen view for this year could be at risk if the Fed cuts rates earlier than expected or if the Bank of Japan enters a proper rate hiking cycle in 2023.