The weakening yen is unpopular in Japan and pressure is mounting on politicians for action but there are no easy answers.
Add in the weakening currency and there is a tidal wave of money chasing this trade, which is a classic carry trade.
2) Intervention is an option but the long history of intervention shows that it only helps when fundamentals are improving.
The Japanese government – which order the intervention – waved a bit of a white flag this week in saying that it wasn’t currently weighing intervention.
3) There was some hesitancy to push the yen lower ahead of the Bank of Japan.
What Japan – and much of the world – is hoping for is a turn in the US dollar and global inflation.
Alternatively, if a recession looks like it’s on the horizon, there will be a surge in the yen.
The market initially focused on this week’s US inflation numbers – which were hot – but eventually pivoted to focusing on growth.
There is growing pressure on politicians to take action due to the unpopularity of the weakening yen in Japan, but there are no simple solutions. I discussed the following concerns with BNNBloomberg.
1) The primary driver is the difference in rates. You can receive 0.9 percent annually by purchasing a 10-year Japanese government bond or 4.7 percent annually by purchasing a US 10-year bond. This trade, which is a classic carry trade, is being chased by a tidal wave of money due to the weakening currency.
2) Although intervention has a long history, its effectiveness is limited to situations in which the fundamentals are improving. The Japanese government, which ordered the intervention, raised a little white flag this week when it declared that it was not considering intervening right now. That was a mistake because it encouraged the market to advance.
3) There was reluctance to lower the yen before the Bank of Japan. They raised rates in March for the first time in seventeen years, which caused some concern that they might trigger another move, but the move turned out to be benign. If their optimistic economic forecasts come to pass, they set out an ambiguous timetable for hiking.
4) There is no increase in inflation. Japan managed to escape the global inflationary storm, and as a result, prices are now starting to decline. Tokyo’s CPI report today came in at 1.6 percent, versus the expected 2 percent. The market noticed that the miss was primarily caused by a one-time change in high school tuition rates, but this headline won’t raise inflation expectations.
The Japanese government can increase spending to spur growth, but that hasn’t worked and the nation is heavily indebted, so what are the other options? Although there have been some encouraging signs regarding wages this spring, it will take two to three years for them to become ingrained, so hiking now would be misguided.
Therefore, it is difficult to see a floor and the relief valve is the currency.
Japan, along with most of the world, is hoping for a turnaround in both global inflation and the US dollar. These rate differences get closer if other central banks start to cut. On the other hand, the value of the yen will increase if a recession appears to be approaching.
It is a race to the exits in a carry trade when there is volatility, but the money moves slowly and steadily. Money was flowing into the high-yielding AUD and NZD just prior to the financial crisis, and this dynamic unwound at a dizzying rate, with days when currency movements were as high as 10%.
They are currently limited to waiting, though.
why the US dollar side of the trade is driven.
The fear of inflation, particularly the fear that the Fed will have to hike again, is what is driving the dollar bid at the moment. Regarding that front, I believe we’re getting close to the extreme of pessimism.
The market finally shifted its attention to growth after initially focusing on the US inflation figures from this week, which were shocking. Wal-Mart stressed this point on Thursday and even mentioned bringing down the price of meat and vegetables. If you look at the prices of goods, they are flat year over year.
While Canada’s deficit is 1.4% of GDP, the US government is likewise experiencing a 7% deficit. It won’t happen until late 2025, at the earliest, but depending on the outcome of the election, the market may begin to price it in. In my opinion, the US dollar will finally turn when the fiscal belt tightens.
