Welcome

Room to Breathe

September 17, 2024

Finally, the BOJ and MOF can lean back. This piece will explain why I think the Japanese Yen and JGB markets are temporarily under control. An overview:

Quick Background

Fashionably late is right on time, and no one cares about appearances more than the US Fed. Entering 2024 big banks and speculators were confident the first half of the year would yield a recession and Fed rate cuts. Neither have happened thus far, but cracks are beginning to emerge.

Most interesting to me has been the weakness in the Japanese Yen, catalyzed by the ~5.5% difference in FED/ BOJ federal funds rate. Over the first four months of 2024 USD/JPY climbed from 140 to 160, a rapid ~14% rise spurred by the Fed’s higher for longer policy. In 2022, when the Fed started hiking rates (and the BOJ did not), USDJPY was ~115.

A weak currency is unbearable for Japan for a variety of reasons. Energy and commodities imported in foreign currencies become more expensive. This effects households and corporations, eating away at disposable income and margins. Tourists also flooded the country, and traveling abroad became much more expensive for Japanese citizens. No fun for anyone.

After a few years of continual weakness, the public began to fear for their (abnormally high) cash savings, and the risk of cyclical panic and capital flight emerged. Strengthening the Yen became priority #1 for the MOF, BOJ, and politicians when USD/JPY touched 160 at the end of April 2024. By the time it broke through 160 in July, despite multiple MOF interventions totaling more than 10 trillion Yen, there was no other issue.

Fortunately for the Japanese currency managers, the FED is going to cut rates tomorrow.

Now – EOY

JGBs will continue to hold strong below or around 1% for the benchmark 10-year, and the Yen will continue to flex all over those who piled on while it was down. The only time I’ll spend on the Yen carry trade is to say that’s not a place I would want to be. The cuts will begin tomorrow, and won’t stop till the US markets stop, drop, and pop. The EU, Australia, and other Western states are all onboard, as rate cuts are politically popular.

Not only are most developed country central banks cutting rates, Japan is just starting to raise them. The 150% hike (from 0.10 to 0.25) in August catalyzed a quick drop in USD/JPY, and JGB yields.

As the Fed/ BOJ federal fund rate differences starts to narrow, the Yen will continue to strengthen against the Dollar. This is just how it works, assuming all else is held equal. If you don’t understand this you should read a primer on the relationship between central bank policy rates and currencies.

The JGB market will benefit from a narrowing Dollar/ Yen interest rate differential as well. Capital will be repatriated to Japan, tired of the so-called greener pastures abroad. Much of this money, fresh off vacation and filled with patriotic spirit, will buy JGBs, none of which are more popular than the 10-year.

As the rate cutting cycle hits its stride in the US, EU, and other developed countries, the BOJ and MOF can finally kick back, crack a cold one (domestic of course), and let the narrowing policy rates do the work for them. No more currency interventions, no more open market JGB operations- for now.

How Long Will it Last

Given the affinity central banks have for zero percent interest rates nowadays, it seems likely the Fed and it’s followers are headed that way. If this is true, much of the Yen weakness since March 2022 could be undone, and 110 – 120 USD/JPY is in play.

Markets are forward looking, so a portion of the anticipated Fed rate cuts are already priced in. At some point it will become clear when and at what level the Fed will end the rate cutting cycle. At that point or soon after, the MOF and BOJ will be back on the hot seat.

Of course, many things aside from central bank federal fund policy rates effect currency values. It is hard to anticipate which unelected bureaucrat will outdo the rest in funny money policies. Direct government handouts, unfunded fiscal deficits or tax cuts, and other loose money/ stimulative policies matter.

For now, though, all is clear in the land of the rising sun.

Comments

Join the discussion on 'Room to Breathe'

Leave a Reply

Your email address will not be published. Required fields are marked *