Why Even a Historic BOJ Rate Hike Has Failed to Save the Yen

Economic

Summary:

Japan's yield remains world's lowest, real exports stagnant.

Japan’s first interest rate hike in 17 years has failed to deliver the boost to the yen that policymakers had hoped for, with strategists pointing to four key reasons for the currency to remain weak for now.

At the top of the list is rates in Japan that remain much lower than the rest of the world, followed by speculation the yen hasn’t weakened fast enough to invite intervention, low market volatility that favors carry trades, and signs the depreciating currency isn’t bolstering exports.

While officials have said the yen isn’t moving in line with fundamentals, and that they will take appropriate steps to stem declines, the currency remains near the three-decade low of 151.97 per dollar set last week.

“The yen is likely to remain weak,” said Daisaku Ueno, chief foreign-exchange strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “Despite the rate hike, there’s no prospect to see positive real interest rates in the near term, which makes the appeal of the yen very poor.”

Low Yields

Source: Bloomberg

After accounting for inflation, Japan’s 10-year yield stands around minus 0.650%, compared with about 2% in the US and 0.27% in Germany.

That’s a huge incentive for traders to borrow in yen to invest in high-yielding assets in a strategy known as the carry trade. It’s a headache that just won’t go away for the Japanese government, which has to deal with political fallout of the weak yen pushing up the cost of living for households.

While the Bank of Japan is expected to increase borrowing costs further this year, as its major counterparts start to cut interest rates, the exact timing is uncertain and it will take time to meaningfully narrow the nation’s yawning yield gap with its peers.

“Surplus funds naturally flow from lower-yield places to higher-yielding countries, just like water flows from high to low,” said Ayako Sera, market strategist at Sumitomo Mitsui Trust Bank Ltd. “There’s no reason to keep surplus funds here where the policy rate is around zero.”

Intervention Uncertainty

Currency traders are on high alert for possible intervention to support the yen by Japan’s Ministry of Finance after officials ratcheted up their warnings. Yet the hurdle to leap from words to actions appears to be high.Traders focused on quantifiable guidance from the government’s top currency official, Masato Kanda, are looking to 10-yen moves over one month against the dollar as a key metric.

Kanda Index Suggests Yen Intervention Still Unlikely

Why Even a Historic BOJ Rate Hike Has Failed to Save the Yen_2

Source: Bloomberg

The yen still hasn’t moved that much in recent weeks, according to a gauge that measures the currency’s swings from its highest to lowest against the dollar in a rolling 28-day window. The last time the dollar-yen reached that threshold was in October 2022, when the Ministry of Finance intervened twice. It’s now less than half that level.

Japan is committed to international agreements calling on governments to allow markets to determine exchange rates. But there’s some scope for intervention in response to excessive moves.

Falling Volatility

Why Even a Historic BOJ Rate Hike Has Failed to Save the Yen_3

Source: Commodity Futures Trading Commission

Volatility has come down in the currency market, boosting the allure of carry trades for investors, who have less to worry about market fluctuations wiping out profits.

Leveraged funds and asset managers combined pushed up bearish yen bets to the most since April 2022 last month, according to data from the Commodity Futures Trading Commission. A JPMorgan Chase & Co. gauge of global currency volatility has halved from a recent peak in September 2022.

Falling Exports

Economics textbooks say that a weak currency should increase exports by making products more affordable abroad, and that the foreign demand will eventually strengthen the currency. But that’s not really happening now in Japan, with an export boost absent.

The yen’s nominal effective exchange rate, an indicator of the currency’s strength against those of Japan’s major trading peers, has slumped almost 25% since the end of 2020. But a BOJ gauge for inflation-adjusted exports has fallen 3.3% during the period.

Source: Bank Of Japan

That may reflect Japanese companies increasingly producing goods overseas rather than exporting, while fund flows out of the country to seek higher investment returns abroad also are a headwind for the yen.

An improved trade balance should be part of the adjustment process for a currency, Steven Englander, head of global G-10 FX research at Standard Chartered Bank, wrote in a research note last week. “The absence of such an improvement weakens the case for a yen rebound.”

Source: Bloomberg

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Why Even a Historic BOJ Rate Hike Has Failed to Save the Yen

Low Yields

Source: Bloomberg

Intervention Uncertainty

Kanda Index Suggests Yen Intervention Still Unlikely

Source: Bloomberg

Falling Volatility

Source: Commodity Futures Trading Commission

Falling Exports

Source: Bank Of Japan

Source: Bloomberg

Risk Disclosure