Japan’s Been Spending Billions To Slow The Yen’s Slide. It’s Not Working

Japan’s Been Spending Billions To Slow The Yen’s Slide. It’s Not Working
Russell Burns

over 1 year ago5 mins

  • Japan has intervened in the currency market this year for the first time since 2011, buying up yen and selling US dollars, in an attempt to slow the pace of the yen's decline.

  • The yen has been at 32-year lows, largely because the Bank of Japan (BoJ) has maintained ultralow interest rates, while its other advanced economy peers have raised rates. Higher rates make a currency more attractive to international savers and investors.

  • The interventions have shown limited effectiveness, but with inflation in Japan beginning to build and a new BoJ governor expected to take office in April, there’s rising speculation that Japan’s interest rates may be nudged higher, which could help the yen strengthen.

Japan has intervened in the currency market this year for the first time since 2011, buying up yen and selling US dollars, in an attempt to slow the pace of the yen's decline.

The yen has been at 32-year lows, largely because the Bank of Japan (BoJ) has maintained ultralow interest rates, while its other advanced economy peers have raised rates. Higher rates make a currency more attractive to international savers and investors.

The interventions have shown limited effectiveness, but with inflation in Japan beginning to build and a new BoJ governor expected to take office in April, there’s rising speculation that Japan’s interest rates may be nudged higher, which could help the yen strengthen.

On Friday (and possibly again on Monday), Japan intervened in the currency market, buying yen for the second-straight month, in an attempt to slow its rapid decline. It's an unusual move for Japan: the last time it intervened in the foreign-exchange market was after the Fukushima nuclear disaster in 2011, when policymakers sold yen to contain its rapid climb. So, given the unusual nature of this kind of move, it’s worth considering why Japan’s doing this now and what the opportunity is.

What’s going on with the yen?

The yen has been at 32-year lows of late and it’s been the weakest of the major currencies this year, having fallen 29% against the super-strong US dollar, and even declining 8% against the floundering British pound.

The Japanese yen’s performance against the other six biggest advanced-economy currencies, in percentage terms. Source: Bloomberg.
The Japanese yen’s performance against the other six biggest advanced-economy currencies, in percentage terms. Source: Bloomberg.

And the yen really can’t help it. See, the key driver in currency markets this year has been rising interest rates. Higher rates make a currency more attractive to foreign investors and savers, after all. And in the US, Europe, the UK, Australia, Canada, and Switzerland, rates have been rising, at least a little. Meanwhile, in Japan, interest rates have stayed near zero.

If we compare the yield on the two-year US Treasury (government bond) which is currently 4.47% – what you earn if you hold the bonds for a year – and Japan, where the yield on the two-year government bond is zero, the difference is 4.47% – this is called the yield spread.

Take a look at the “yield spread”, or the difference in returns, on the two-year US Treasury bond compared to the two-year Japanese government bond (right-hand axis). With the US bond yielding 4.47% and Japan’s yielding zero, the spread obviously stands now at 4.47%. Now, look at how closely “dollar-yen”, the USD/JPY currency trading pair (left-hand axis), is tracking the yield spread. As the yield spread widens, so does the dollar’s edge over the yen.

The USD/JPY currency trading pair and the US-versus-Japan two-year government bond yield differential. Source: Bloomberg.
The USD/JPY currency trading pair and the US-versus-Japan two-year government bond yield differential. Source: Bloomberg.

Is there anything on the horizon that could boost the yen?

Like most major central banks, the Bank of Japan (BoJ) has an inflation target: it aims to see the country’s consumer price index (CPI) rise at an annual pace of about 2%. In September Japan’s CPI hit a new eight-year high at 3%, overshooting the 2% target for the sixth consecutive month. But, the BoJ believes the overshoot is temporary – because while prices have risen, wages largely haven’t – and so it’s been sticking with its ultralow interest rate policy stance.

But wages in some parts of the economy may be about to rise. You see, Japan has just lifted Covid restrictions and fully re-opened its borders, and the influx of tourists is likely to spur a flood of hiring – a tough prospect in Japan’s already tight labor market (the unemployment rate is just 2.5%). For employers to hire, they may have to offer more generous pay.

The BOJ uses yield curve control to keep interest rates low – and has set the 10-year bond yield to be around zero, with an allowable band of +/- 0.25%. But there’s speculation that the policy could change – the band could widen – when a new BoJ governor takes office in April 2023. And if it did, that could help strengthen the yen.

On the other hand, if the Federal Reserve (the Fed), which has been aggressively hiking rates, were to halt those hikes, and even begin to lower interest rates, the yen could gain against the greenback as the yield spread shrinks. But that’s not exactly expected to happen soon.

So are there likely to be more interventions then?

In Japan, the BoJ decides monetary policy (e.g. interest rates), but the Ministry of Finance (MoF) decides when it’s time for the BoJ to intervene in the foreign exchange market. And it makes that decision based on a range of factors. After all, there are winners and losers to having a weak currency. Japanese companies with huge overseas operations may benefit from the weak yen, because it will increase the value of the money they make abroad. But households and domestically focused businesses may be hurt because of the higher cost of imported food and energy. Publicly, the MoF has said it’s concerned about the pace of the yen’s decline, but not about its absolute level.

It’s estimated that policymakers spent about $19 billion buying up yen in September’s market intervention, and potentially as much as $37 billion in the past week.

Japan policymakers intervene to buy the yen against the dollar, in September and October 2022. Source: Bloomberg.
Japan policymakers intervene to buy the yen against the dollar, in September and October 2022. Source: Bloomberg.

What’s the opportunity here?

If you think that interest rates are set to remain high in the US and low in Japan, then buying the dollar and selling the yen (i.e. going long USD/JPY) looks sensible enough in the short term. But, remember: there are two potential catalysts for a reversal in 2023, with the change to a new BoJ governor, and the potential for a decline in US interest rates. You can trade currencies directly with your broker or use the Invesco CurrencyShares Japan ETF (ticker: FXY; expense ratio: 0.4%).

Or, you could take a look at Japan’s Nikkei 225 index. It’s down only 6% this year and priced in yen. Its cheap valuations, with Japan’s market trading at a 12x price-to-earnings ratio and a 1.1x price-to-book ratio, have the index looking attractive. With so many big Japanese companies raking in much of their earnings overseas, the weak yen has been boosting their sales and profits, and helping to keep overall market valuations down. As Jon noted here, the iShares MSCI Japan ETF (ticker: EWJ; expense ratio 0.5%) and the Franklin FTSE Japan ETF (FLJP; 0.09%) both offer exposure to large and mid-sized Japanese companies. Just keep in mind, these aren’t currency-hedged, so if the yen weakens further, your investment would too. Just look at the Nikkei 225: it’s fallen 28% in US dollar terms, because of the decline in the yen. If you prefer a hedged ETF, the WisdomTree Japan Hedged ETF (DXJ; 0.48%) protects you from further yen weakness.

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