Yen weakness over?

Yen weakness has been the talk of the town lately, and a quick glance at the chart tells you why. In just 13 trading days the JPY weakened from 116 to 125 against the dollar!

Japan’s in a pretty unique position globally and there’s a few factors that have favoured yen weakness lately.

Inflation:

While the rest of the developed world frets about too high inflation, Japan’s still fretting about too low inflation, much as they have been for the past couple of decades. The deflationary psychology is so entrenched that companies won’t raise prices for fear of buyer strikes.

Japan’s latest CPI print was 0.9% YoY. Compare that to the US for example, where inflation’s running at 7.5% YoY and there’s a huge inflation divergence opening up!

Central Banks:

All of which starts to open up a big interest rate divergence between the US Federal Reserve & The Bank of Japan. Over the next 12 months, overnight interest swaps are pricing a further 2.4% of hikes from the Fed. Compare this to the Bank of Japan where a token gesture of 0.07% is priced in and the difference is crystal clear.

US Bond Yields:

There’s a well-known correlation between the US 10 year yield and USDJPY. There are no perfect correlations, but we can definitely see the two moving in lockstep lately.

The Bank of Japan employs Yield Curve Control to keep Japanese yields low.

Seasonal factors are in play too. JPY weakness later in March can often be in play as the Japanese fiscal year closes.

The seasonality influence ends soon, but will those other factors remain in place? Anything’s possible, but it’s hard to see the Bank of Japan pivoting aggressively to a new policy given recent commentary.

In their latest meeting minutes, one BoJ members comments summed up the mood:

"Unlike the United States or Britain, Japan isn't in a situation where inflation continuously exceeds 2%...It's therefore important to support the economy's recovery from the coronavirus pandemic by maintaining monetary easing,"

Bank of Japan (BOJ) Governor Haruhiko Kuroda and Prime Minister Fumio Kishida met earlier this week, a sign that official levels of discomfort are high.

Policymakers have recently stated that yen weakness is no bad thing, but the speed and volatility of the moves in FX markets has led some to speculate that the BoJ may intervene. The meeting has been cited as a reason that traders pared their bets. This kind of intervention is not unprecedented in volatile FX markets.

It seems there’s not a great deal that Japan can do to change their secular trends, and low rates are expected to remain a feature of their economy.

But FX markets are often games of relativity. Declining commodity prices, especially oil & gas could improve their terms of trade (Japan is a major energy importer). Likewise, if inflation starts to slow elsewhere (especially in the US), and traders begin to lower their expectations of Fed hawkishness, the yen could further strengthen.

Not investment advice. Past performance does not guarantee or predict future performance.