The pressure on Japanese yen
There is unrelenting pressure on the Japanese yen, despite an official intervention from the authorities in September and constant verbal intervention. USDJPY rose past 150 for the first time since August 1990, and is on its way to closing the gap to the 160 high seen in April 1990.
While intervention chatter remains loud, authorities have stayed away from claiming their presence in the markets given the limited impact their efforts are having. Market participants would likely be encouraged to challenge the yen further if it was confirmed that BOJ was intervening, and it isn’t having much of an impact.
Further intervention fears will pick up as we head into the week of Bank of Japan meeting on 28 October and the FOMC meeting in the following week on 2 November. Not just USDJPY, but EURJPY and GBPJPY are also above the levels at which we saw previous yen intervention on September 22 (last BOJ meeting). The yen is only stronger against the AUD since that day. We have discussed here how intervention expectations can be traded in USDJPY or the other yen crosses.
The pressure on Japanese bonds
Meanwhile, bond investors continue to test BOJ’s commitment to yield curve control policy and are hedging by positioning on the short side in Japanese government bonds (JGBs). Ten-year swap rates, a key tool for international funds to express a view on Japanese yields, are more than 30bps higher than the BOJ’s 0.25% cap on 10-year yields and at 8-year highs. Officials have pushed back on “speculative” attacks on Japanese bond markets, and the rise in 10-year yields above the 0.25% cap, with a series of unscheduled asset purchases.
September CPI surge to 3.0% y/y on the core measure was the highest in over 30 years, and more gains can be expected into the end of the year and weak yen continues to propel import price pressures and mobile phone fees will rise as well. This will also continue to pile in pressure on the BOJ to follow the global tightening wave, but will continue to be discounted to be energy-driven.
BOJ faces a conundrum
If BOJ wants to stop yen depreciation, it will need to adjust the yield curve control (YCC) policy such as raising its yield target or widening the movement range around it. Any of such moves would effectively be viewed as a hawkish pivot or a rate hike and would roil not just Japan’s domestic bond markets but also global as yields could see a fresh surge. Even hints of a policy review could send expectations of a BOJ pivot roaring, and mark a strong recovery in the Japanese yen.
However, if the BOJ remains committed to YCC and supports the bond market, the next level to watch in USDJPY is 153, but there still remains potentially more room on the upside as long as the Fed hiking cycle continues. This may be accompanied by a huge intervention effort which could knock down USDJPY and other yen crosses by 2-5 big figures, but the move will still likely be reversed.
In summary, between the integrity of YCC and JPY, something has to break. Admittedly, pressures will rise ahead of BOJ’s Oct 27-28 meeting and expectations are for an unchanged policy stance.
Peak Fed hawkishness
A pivot on the YCC by the BOJ sounds complicated. It would mean a significantly higher cost of servicing debt for Japan, which will mean fiscal pressures – something like what happened in the UK but with a much higher magnitude. Japanese households will face a significant stress, with about two-thirds of Japanese mortgages on variable rate, and loan repayments could shoot up substantially.
The fate of the yen will then remain in PM Kishida’s hands, and it is well understood that large amounts will need to be spent and it will be a drain on their FX reserves. Authorities have been hinting at using the weak yen as a tool to their benefit, but pledging support to 10,000 companies, reshoring manufacturing, and focusing on inbound tourism.
The only option then seems to be is status quo, and waiting for the peak Fed hawkishness. With US 10-year Treasury yields above 4.25%, the room on the upside is getting rather limited. If we assume peak Fed hawkishness to play out in Q4 or early Q1, then the pressure on JGBs and the Japanese yen would ease and all the BOJ needs to do is to wait it out.