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- Yen to dollar at its weakest level since 1986
The yen is weak, very weak. Against the U.S. dollar the Japanese currency has reached levels this month that were last seen in 1986. Although it has recovered slightly from the significant low of 161.95 against the dollar, we do not, at present, see a sustained countermove.[1]Even assumptions don’t change the fact that Japan may have intervened in the market yesterday following the release of US consumer prices, supporting the yen. The rapid fall in the yen – it has dropped by about 15% against the dollar this year alone – might be seen as a self-fulfilling prophecy: The yen falls because investors sell, and investors sell because the yen falls. Is the Japanese currency caught in a vicious circle?
The yen’s weakness looms over the foreign exchange market. It is a concern not only for Japan’s central bank but also, increasingly, the government. The Japanese economy relies heavily on imported goods. Pressure to intervene in support of the yen remains high. However, interventions to buy the domestic currency have historically been rare. More often the Bank of Japan (BoJ) has sold yen on the instruction of the Ministry of Finance to prevent damage to the export-dependent economy caused by excessive appreciation and to keep Japanese goods competitive in international markets.
U.S. yield trend drives USD/JPY
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 7/9/24
The Ministry of Finance has emphasized that interventions are not based on specific levels but rather on the speed at which the yen exchange rate changes. The most recent confirmed market intervention in favor of the yen occurred at the end of April / early May this year when the currency pair climbed above the psychological level of 160. It seems, however, that the intervention has not been successful because the yen has weakened again. For a possible market intervention yesterday, there was no confirmation from the Ministry of Finance at first. However, statements by Vice Finance Minister Masato Kanda strongly suggest this direction in our opinion.
In the short term the chances that the yen will strengthen appear quite low. Fundamentals are against it. “The interest differential to the U.S. will likely remain at about 5% for a long time as the Bank of Japan will only adjust the interest rate very gradually. So, U.S. assets remain attractive for Japanese investors,” says Xueming Song, currency strategist at DWS.
Market indicators show yen weakness persisting. The hedge ratio for Japanese institutional investors is low, implying that they do not expect a significantly stronger yen. And the implicit hedging costs are simply too high, due to the interest rate differential to the U.S. The three-month yen basis swap, however, is currently trading near multi-year highs, so that protection against a stronger yen is as cheap for Japanese investors as it has been in a long time.
Any interventions by the Bank of Japan are likely to only temporarily alleviate the yen’s weakness: Japanese retail investors would immediately use the opportunity to invest in the U.S. A reversal of the yen’s weakness is only likely to occur much later this year or next year if the Federal Reserve (Fed) starts to cut interest rates aggressively.
