©Reuters. FILE PHOTO: A Japanese yen note is seen in this illustrative photo taken on June 1, 2017. REUTERS/Thomas White/Illustration/
LONDON (Reuters) – The Japanese yen fell against the US dollar this week to levels last seen in early 2002.
The scale of the move is having an impact on the domestic economy as import prices in yen terms rise at a record pace each year, putting pressure on household balance sheets.
The Bank of Japan and the Japanese government issued a rare joint statement on Friday that they could intervene if weakness continues.
So far, the impact of the weakening yen on broader financial markets has been minimal, but that could change if the sell-off accelerates.
Below are key questions about what a falling yen means for the Japanese economy and international markets:
WHY IS THE YEN WEAK?
The yen, the third most traded currency globally, is now at nearly 134 per dollar after starting 2022 at 115. With the dollar up 16% so far this year, the yen is on course for its biggest annual decline since 2013.
The weakness stems mainly from widening interest rate differentials between Japan and other countries.
While the rest of the world, led by the US Federal Reserve, is aggressively raising interest rates to tame rising inflation, the BOJ has doubled down on loose policy.
The spread between 10-year Japanese government bond yields and that of the United States is 279 basis points – a high of almost 3 1/2 years – while the spread to German yields is 8-year highs.
WILL THE AUTHORITIES INTERVENE?
They certainly say they could.
On Friday, Japan’s government and central bank said they were concerned about recent sharp falls, the strongest warning yet that Tokyo could intervene.
The yen quickly recovered from its two-decade low, but not everyone is convinced that actual intervention is likely.
Given the economy’s reliance on exports, Japan has historically focused on stemming a sharp rise in the yen and has taken a hands-on approach to yen weakness, which is more difficult as Japan relies on limited foreign exchange reserves to purchase yen.
The last time Japan intervened to support its currency was in 1998, when the Asian financial crisis prompted rapid capital outflows from the region. Previously, Tokyo intervened to counter the fall of the yen in 1991-1992.
Currency interventions are costly and could easily fail given the difficulty of influencing the yen’s value in global currency markets.
WHAT CAN STOP THE DECLINE?
A sharp improvement in growth prospects as the country reopens its post-COVID borders and higher inflation could change the BOJ’s dovish stance.
Japan’s core consumer prices were up 2.1% yoy in April, beating the BOJ’s 2% inflation target for the first time in seven years.
“The yen’s fall could stop if the BOJ changes course and becomes hawkish,” said Francesca Fornasari, head of currency solutions at Insight Investments.
Any sign of interest rates peaking outside of Japan could also lead to a recovery rally. However, there is no sign of that yet as US interest rates are set to peak at 3.5% in mid-2023 according to futures markets.
WILL A WEAKER YEN STRENGTHEN THE ECONOMY?
The yen has weakened back to recent 7-year lows against the yen and is making fresh multi-year lows against the Korean won and Taiwanese dollar, which should provide some relief from Japan’s growing trade deficit.
Some, like John Vail, chief global strategist at Nikko Asset Management, say currency weakness is crucial for the Japanese economy to maintain its competitiveness as a safe source of supply chain diversification.
The yen’s decline also makes its stock market more attractive to foreign investors, who see it as undervalued compared to the European and US markets. Japanese stocks have outperformed their peers in 2022, although they are still down as investors around the world dump riskier assets.
WHAT DOES THIS MEAN FOR FOREIGN EXCHANGE MARKETS?
The yen has long been the currency of choice for investors doing carry trades, where they borrow in a low-yielding currency like the yen to invest in higher-yielding currencies like the US or Canadian dollars.
A strategy that borrows in yen and invests in an equal basket of US, Australian and Canadian dollars could have returned 13% so far in 2022, according to Refinitiv data.
But the speed of the yen’s fall and questions about policymakers’ intervention are fueling unease among investors, particularly on short bets against the yen near six-month highs.
Further volatility and weakness could undermine its attractiveness as a funding currency.
WHAT ABOUT DOMESTIC INVESTORS?
The weakness of the yen is causing difficulties for Japanese investors.
Yields are high and rising, making foreign bonds much more attractive. However, this also means that the costs of currency hedging are increasing.
As a result, Japanese investors can often only take advantage of the higher yields by buying foreign bonds unsecured.
But with the yen at such a low level, it is difficult for investors to bear such currency risks as the yen appreciates. Even a modest move back to 115-120 where we were 4 months ago would erode years of yield advantage.
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