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Japan's BOJ Abandons Debt to Protect Yen: End of Depreciation?
The Bank of Japan has made another move.
On May 13th, local time, the Bank of Japan (BOJ) took the rare step of "abandoning debt to protect the exchange rate," reducing its purchases of Japanese government bonds. This action was interpreted by the market as an attempt to save the yen. Following the action, Japanese bonds were sold off, yields rose, and the yen rebounded against the US dollar. However, the market generally believes that the action is effective in the short term, but in the long term, it still depends on the interest rate differential between the US and Japan.
The US stance on the same day showed that it is still waiting and seeing regarding joint currency market intervention with Japan.
The yen's short-selling sentiment has eased.
On May 13th, local time, the Bank of Japan reduced its bond purchases, cutting the amount of 5-10 year Japanese government bonds from 475 billion yen to 425 billion yen. Japanese government bond yields rose across the board, with 20-year Japanese bond yields rising to 1.77%, the highest since 2013, and 30-year Japanese bond yields reaching the highest level since at least 2011. The benchmark 10-year Japanese government bond yield also rose to 0.96%, just slightly below the peak level of more than a decade. The US dollar against the yen plunged more than 40 points in the short term to around 155.49.
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Mitsubishi UFJ Morgan Stanley's senior fixed income strategist, Takahiro Otsuka, said: "The BOJ's reduction in government bond purchases is quite unexpected and may help to raise Japanese bond yields. Therefore, it is difficult not to view this action as a response to the recent depreciation of the yen. The Japanese bond market may also experience more volatility as a result."
In fact, the Japanese government may have already intervened in the currency market. On April 29th, although the Japanese Ministry of Finance did not respond to whether it had intervened in the exchange rate, Deputy Minister of Finance, Masato Kanda, stated that appropriate measures would continue to be taken to deal with excessive foreign exchange fluctuations, and whether foreign exchange intervention had been carried out would be announced at the end of May. The market speculated that the Japanese authorities may have conducted two foreign exchange interventions on April 29th and May 2nd, which led to the yen's rapid rise from 160 to around the 152 level against the US dollar.
However, the Governor of the Bank of Japan has always been reserved about intervening in the currency market with monetary policy. On May 8th, he suddenly stated that a rapid, one-sided decline in the yen is detrimental to the Japanese economy and is not desirable, and that monetary policy measures may be taken in response to currency market fluctuations. The latest summary of the BOJ's April meeting also showed that members of the monetary committee are closely monitoring the impact of the yen's weakness on inflation and believe that the pace of interest rate hikes may be accelerated as a result. This has led investors to speculate that the BOJ will raise interest rates earlier rather than later and reduce the scale of bond purchases.
Ataru Okumura, a senior interest rate strategist at Nomura Securities in Tokyo, wrote in a report that the urgency for the BOJ to take action to support the yen has risen to the level of November 2022, and it is expected that the BOJ will take action at its next meeting in June, including changing the scale of bond purchases. Regarding the shift in the BOJ's stance, Shoki Omori, Chief Strategist at Mizuho Securities in Tokyo, believes: "The BOJ seems to be under pressure from the government to take action to address the depreciation of the yen and the loose financial environment."
More interestingly, after the BOJ's move on the 13th, the Japanese Ministry of Finance stated on the 14th that the government will work closely with the BOJ on foreign exchange issues to ensure that both sides do not friction and hinder each other in achieving common policy goals. "Maintaining close policy coordination is important to avoid hindering the implementation of other policies and reducing the overall effectiveness of policy-making," he said.Japanese bond investors are still apprehensive about the Bank of Japan's recent actions. Previously, global funds had been selling 10-year Japanese government bonds for 12 consecutive weeks, setting the longest consecutive selling record since 2014, a trend that only began to reverse in May. Katsutoshi Inadome, a senior strategist at Sumitomo Mitsui Trust Asset Management, said: "The market is uncertain whether this reduction in bond purchases is a one-time event. In fact, another cut could happen at any time, possibly as early as this Friday, which would continue to put upward pressure on Japanese bond yields."
The long-term value of the yen still depends on the Federal Reserve.
A series of interventions have indeed eased investors' short-term bearish sentiment. The latest data released by the U.S. Commodity Futures Trading Commission (CFTC) shows that as of the week ending May 7th, hedge funds held over 81,000 yen short contracts, a decrease of nearly 27,000 from the previous week, marking the largest drop since March 2020.
However, many market participants interviewed by journalists previously believe that the long-term trend of the yen is more dependent on the Federal Reserve than the Bank of Japan. Nagai Shigeto, the Chief Economist for Japan at Oxford Economics, told reporters that the yen's weakness is unlikely to be the main trigger for further interest rate hikes in Japan. "More importantly, unless financial markets anticipate that the Bank of Japan will take a series of interest rate hikes to counter accelerating inflation, the Bank of Japan's rate hikes will have a limited effect on boosting the yen. Moreover, it is also unlikely that the Bank of Japan will raise rates multiple times. The risk of the Federal Reserve maintaining high yields for a long time could extend the period of yen weakness and significantly drive up Japan's import inflation."
Greg Hirt, Chief Investment Director of Global Multi-Asset at Allianz Investment, also told reporters, "We maintain a neutral view on the yen against the dollar because, to date, the Federal Reserve has been the dominant force in the trend of this exchange rate. We will adopt a wait-and-see attitude until we see stronger drivers, such as data supporting the Federal Reserve to cut rates faster than expected, or any decisive defensive measures from the Bank of Japan."
It is not difficult to find from the historical trend of the yen exchange rate that exchange rate changes are influenced by a variety of factors, including economic fundamentals, interest rate differentials, and inflation. The strategy team of Ping An Bank believes that exchange rate intervention measures are effective in the short term but will not drive a trend reversal in the yen. They are more likely to slow down the speed of yen depreciation. The key to this round of yen movement lies in the shift in the Bank of Japan's monetary policy and the situation with the dollar. In the short term, the yen will continue to maintain a weak trend. In the medium to long term, the marginal effect of this round of rapid yen depreciation on attracting foreign capital inflows is weakening. Recently, there has been an increase in the volatility of foreign capital flows, and Japanese authorities may consider lowering the upper limit of yen depreciation. Alvin Tan, Head of Foreign Exchange Strategy for Asia at RBC Capital Markets in Singapore, believes that in the face of a "huge" Japan-U.S. interest rate differential, if U.S. interest rates do not decrease, the impact of Japanese intervention will quickly dissipate, and the dollar-yen exchange rate will return to the 160 level.
The United States remains reserved about joint intervention.
Richard C. Koo, Chief Economist at Nomura Research Institute, said in an exclusive interview with First Financial Journalists last week that the depreciation of the yen against the dollar is partly caused by the fundamental disconnect between free trade and free capital flows. A super-strong dollar, both in the past and this time, could lead to a resurgence of U.S. trade protectionist sentiment. The "Plaza Accord" of that year and the example of former U.S. President Trump's intervention in the strong dollar show that by the government acting very tough and scaring off foreign exchange market speculators and investors, the government can indeed change or intervene in exchange rates.
"To save free trade, we must control the number of people who think they are losers of American free trade. The only way is through exchange rate intervention to make the dollar fall, making more Americans less averse to free trade. I am glad that the United States, Japan, and South Korea have recently met to discuss the issue of the dollar being too strong. I have known U.S. Treasury Secretary Yellen for a long time, and I have also written to her before, suggesting that she take action before it's too late," he said.
However, judging from the latest statements, the United States remains reserved about joint intervention. The U.S. Treasury Secretary said on the 13th, "Countries can conduct foreign exchange intervention, but without more fundamental policy changes, intervention is not always effective. We still believe that this situation (intervening in the foreign exchange market) should rarely occur, and if it does, it should be communicated with trade partners."Coincidentally, the International Monetary Fund (IMF) also stated that Japan's commitment to allowing flexible fluctuations of the yen will help the Bank of Japan focus on achieving price stability, and it has warned against the growing calls in the market to use monetary policy to alleviate the downward pressure on the yen.
Bank of America stated on the 13th that if the United States were to jointly intervene with Japan to support the yen, it would pose widespread risks to the global financial system. The bank's strategist, Alex Cohen, believes that the United States should only take action when "market volatility is excessive or disorderly and lacks liquidity." "Although by any reasonable measure, the yen does appear to be undervalued, it is also difficult to argue that the current exchange rate of the dollar against the yen is unreasonable. Based on this, the United States acquiescing to Japan's unilateral intervention is already the greatest concession the U.S. Treasury is currently willing to make," he added. "In a more moderate inflationary environment, the benefits of a weaker dollar for the United States would be more apparent. However, with the Federal Reserve not yet confident in fully controlling inflation, selling dollars in conjunction with coordinated intervention would lead to incoherence in Federal Reserve policy."
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