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Goldman Sachs says a material fall in the Dollar to Yen exchange rate (USD/JPY) is some way off as a "stronger for longer" FX regime will define the coming months.

"We still see limited scope for Yen appreciation," says a weekly note from Goldman Sachs's FX strategy team.

There is a building consensus amongst the foreign exchange research community that 2024 will be a year in which the Dollar retreats in response to interest rate cuts at the Federal Reserve and improving global growth.

One expression of this Dollar weakness is a falling Dollar-Yen exchange rate, given the significant rally seen in the pair over recent years, rising 44% since 2021's lows to test levels at 150.

Recent days have seen Dollar-Yen retreat from 150, and market chatter suggests this could be a long-term high-water marker for the pair ahead of a sustained retreat.

However, Goldman Sachs analysis suggests the decline is more a function of positioning adjustment as opposed to any substantive shift in macroeconomic fundamentals.

"Equities and the 10-year rate differential were both roughly unchanged over that period, suggesting that unwinds of long USD/JPY positioning may have been the biggest driver," says Goldman Sachs.

The investment bank's analysts continue to expect the Yen to be primarily driven by the macroeconomics fundamentals, especially as they are "more dovish than the market" on a potential exit from negative interest rates by the Bank of Japan.

To be sure, coming months won't be devoid of Japanese Yen strength as Goldman Sachs says there will be periods of lower real U.S. rates as the market presses the “return of the Fed put” narrative, which should relieve some of the upside pressure in USD/JPY.

"But we still see limited scope for Yen appreciation as any decline in US yields would likely be short-lived without a signal from the FOMC that earlier, non-recessionary cuts are on the table—or, more significantly, without evidence of an imminent US recession," says Goldman Sachs.

The Dollar-Yen outlook is therefore a bumpy one, but "we see the risks as skewed towards an even “stronger for longer” Dollar in 2024, likely coinciding with more persistent Yen weakness," says Goldman Sachs.