This week, the yen touched a four-year low of just above 115 against the dollar. The current wave of JPY weakness, which started in late September, has been driven by higher US treasury yields as well as by the broad-based strength of the dollar due to inflation concerns and strong growth momentum.
“Expectations for Federal Open Market Committee policy normalization have not only lifted the 10‑year Treasury yield but have also widened the spread between US and Japan 10‑year swaps – which is supportive for USD/JPY,” explains Kim Mundy, currency strategist at Commonwealth Bank of Australia (CBA).
The last intervention to sell USD and buy JPY was probably … amid the Asian financial crisis
Joey Chew, HSBC
The Bank of Japan’s (BoJ) ultra-accommodative stance has helped to force the yen downwards and the difference in policy between the central banks of Japan and US will become even more pronounced if, as is expected, the Federal Reserve starts hiking interest rates in early 2022 while the BoJ maintains its -0.1% short-term rate.
According to Adam Button, chief currency analyst at ForexLive, the market is sending a strong signal that inflation is here. “The bond market is rapidly pricing in rate hikes outside of Japan and we are witnessing the rebirth of the carry trade,” he says. “In addition, the market is increasingly comfortable that we have seen the worst of Covid.”
Analysts agree that it would require a much greater fall in the value of the yen for the Japanese government to contemplate intervening in the market, despite the effect on the cost of imported fuel and food.
Jeff Halley, Apac senior market analyst at Oanda, reckons USD/JPY would have to breach 130 before the ministry of finance would start buying the currency.
Haruhiko Kuroda, governor of the BoJ, said in late October that a weaker yen was “definitely positive” for the economy and that under current conditions there was more merit than demerit in maintaining ultra-loose monetary policy.
Japan has structurally low inflation and growth, so the market does not expect the BoJ to change policy for the foreseeable future, which makes JPY a favourable funding currency.
JPY had to choose whether it followed the weakness in equities and strengthened or followed rates and weakened
Daniel Been, ANZ Research
“Moreover, Japan is a high-savings economy, so some market participants believe that there would be large outflows from residents to chase higher yields in the US,” says Joey Chew, senior Asia FX strategist at HSBC. “We have our reservations about this theory, but acknowledge that bond outflows in September were the most significant since November 2020.”
Chew notes that FX intervention by Japan is almost unprecedented this century. “The last time was in the second half of 2011 when Japan bought USD after USD-JPY plunged in the wake of the Tohoku earthquake and tsunami,” she adds. “The last intervention to sell USD and buy JPY was probably in April 1998, amid the Asian financial crisis.”
However, none of this means the yen will definitely continue to fall. As a safe-haven currency, it is prone to periods of strength when global uncertainty rises. For this reason, CBA’s Mundy suggests a setback in the global economic recovery – for instance, from waning Delta-variant immunity or a new malignant Covid variant – could result in periodic bouts of JPY strength.
“We also think there is a risk USD/JPY could fall if short-term interest-rate markets price a global tightening cycle that is so strong it causes equities to correct lower,” she adds.
Daniel Been, head of FX and G3 research at ANZ Research, acknowledges that JPY weakening alongside equity markets is relatively unusual behaviour.
“The reason for this divergence is that we were in a period where equities were falling, but rates were rising,” he explains. “Normally, a shock which pushes equities lower would also drive yields down. This breakdown in the equity-bond correlation meant JPY had to choose whether it followed the weakness in equities and strengthened or followed rates and weakened.
Officials might show more concern over JPY weakness, starting with perhaps jawboning tactics
Saktiandi Supaat, Maybank
“As we look ahead, should the correlation between equities and rates remain positive, this dilemma will remain in place.”
Saktiandi Supaat, head of FX research at Maybank, accepts that there are few signs that the Japanese government wants to intervene in the market, but notes emerging concerns over the impact of a weaker JPY on the country’s energy bill, given its net energy importer status.
“If the confluence of a weaker JPY and elevated energy prices showed discernible signs of hurting the economy, officials might show more concern over JPY weakness, starting with perhaps jawboning tactics,” he says.
The surprise majority secured by prime minister Fumio Kishida in the Japanese parliament’s lower house election on October 31 enabled the ruling Liberal Democratic Party (LDP) to push through a massive stimulus package this month – despite Kishida only assuming the top job a matter of weeks before the election and his party facing criticism for staging the Olympics at a time when citizens were concerned about its impact on Covid infection rates.
“Japan’s recovery from the effects of Covid – as well as Kishida’s vow to support small business – will likely stimulate the economy and see the country return to pre-pandemic levels in 2022, preventing further falls in the yen,” concludes Koichiro Watahiki, head of prime services in Japan for Invast Global.
