Why the Japanese yen is the weakest in 20 years and what it means

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The yen slipped to its lowest level in two decades against the dollar, largely because Japan has a different view of inflation than its global peers. The Bank of Japan stands out among major central banks for its commitment to keeping interest rates low to revive inflation in a sustainable way (after years of trying to stave off deflation), even as prices rise in most other countries in the world. prompt the US Federal Reserve to roll back stimulus and raise rates. A weaker yen can both benefit and harm the economy, businesses and consumers. The steepness of its fall, however, has raised questions about the viability of the BOJ’s policy and the possibility of government intervention in the currency markets.

1. Why is the yen so weak?

The main reason is the movement towards higher interest rates in the United States. This makes dollar-denominated assets more attractive to investors looking for higher yields. The yield on 10-year bonds rose above 3% – the highest since 2018 – as traders continue to bet on an aggressive series of rate hikes from the Federal Reserve. Other factors include the strength of the US economy and its labor market, while Japan continues to lag behind its peers in getting its economy back to pre-pandemic size. Japan’s trade balance, which remains in the red, is also likely to fuel yen weakness.

2. Why isn’t Japan raising rates?

BOJ Governor Haruhiko Kuroda continues to say it is too early to reduce monetary easing and raise rates in Japan, where inflation remains relatively subdued. In April, Japan’s core inflation measure rose 2.1%, above the BOJ’s 2% target. But Kuroda insists he is not yet expected to stay above target in a stable and sustainable way, especially without big salary increases. In contrast, consumer prices in the United States increased by more than 8%. While Kuroda continued in June to insist he would not change course, he rocked markets with a surprise move to negative interest rates in 2016, before finally settling on current policy. , known as yield curve control.

3. What is a yield curve?

It’s a way to show the difference in the reward investors get for choosing to buy short-term versus longer-term debt. Most of the time, they ask for more to lock up their money for longer periods of time, with the greater uncertainty that comes with it. Thus, yield curves generally have an upward slope.

4. What is yield curve control?

Normally, market forces determine the yield curve. The BOJ is taking a more hands-on approach. Through yield curve control, adopted in 2016, it aims to keep 10-year government bond yields around 0% with a quarter of a percentage point, or 25 basis points, of headroom. each side – part of its effort to flood the economy. with cheap money to kick-start growth. The Fed’s interest rate hikes prompted investors to speculate that Japan would follow suit, meaning it would allow yield to rise.

5. What happens if the BOJ gives up control of the yield curve?

It seems very unlikely. But, just like when the Swiss National Bank unexpectedly dropped its cap on the franc in 2015, a surprise reversal by the BOJ has the potential to send shockwaves around the world. If the BOJ even indicated that it would reduce its asset purchases or revise its control of the yield curve, it would likely intensify market volatility and hit Japanese equities. Japanese government bonds would likely see a selloff, adding to upward pressure on borrowing costs globally. The yen would most likely rally so strongly that it would boost the currency markets and harm any traders who use it to fund so-called carry trades, or multinational corporations and banks with large, unhedged exposure to currencies. No one can guess how long the selloff will last, as cash-strapped domestic investors could quickly step in to buy the bonds on a dip. Still, Deutsche Bank AG’s Jim Reid said such a move would have “huge implications for global rates” if it materializes. “If the BOJ throws in the towel,” he wrote in a June 14 report, “then global bond markets are losing a huge foothold.”

6. What did the BOJ do?

After a wave of pressure pushing yields higher, the bank doubled down on its pledge to contain them. He decided in April that he would buy as many bonds as needed each business day to protect the 0.25% cap on 10-year debt yields. This made it clear that bond yields in Japan will remain low even if they rise in the United States.

7. Could the government intervene?

Finance Minister Shunichi Suzuki refrained from even mentioning the possibility of direct intervention in the foreign exchange market. If the government steps in to bolster the yen, it would be the first time since 1998, when it and the United States joined in a massive, coordinated yen-buying spree. Any unilateral action by Japan this time around would likely trigger some form of protest from the United States.

8. What does the weak yen mean for the economy?

When former Prime Minister Shinzo Abe ushered in a period of weaker yen over the past decade, in part to stave off the threat of deflation (a downward spiral that can destroy economies), the business community was widely applauded. . A cheaper yen helps exporters, including auto giant Toyota Motor Corp., as they repatriate profits made overseas. It also makes Japan a more affordable travel destination — outside of pandemic times — for foreigners, bringing tourists money for the hospitality sector and regional economies. The mood is changing now. Costs of raw materials and other goods are rising at the fastest rate in decades, squeezing profits for companies that rely on imports, as everyone feels the pinch of rising energy prices. The rising cost of imported food and other daily necessities is weighing heavily on consumers. As Japan gradually reopens its borders to foreign visitors, any economic benefit will be limited for the time being. With the central bank unlikely to budge, Prime Minister Fumio Kishida has rolled out a series of relief measures, including increased fuel subsidies to lessen the impact on households and businesses.

9. Where Does This Leave Kuroda?

It’s an awkward way to spend the final year of his second five-year term as governor. But he maintained his position that a weak yen is good for the economy as a whole, sticking to protecting the credibility of his policy framework. Kuroda often points out that the Ministry of Finance, not the BOJ, is in charge of foreign exchange matters. Low borrowing costs are also helping Kishida, the prime minister, continue to increase government spending to help a fragile economy recover from the pandemic. That suggests he is unlikely to push for regime change at the central bank when Kuroda’s term ends next April.

(Adds new section 5 on possible implications of abandoning yield curve control)

More stories like this are available at bloomberg.com

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