Yen weakness has the Bank of Japan caught between a rock and a hard place

APAC Strategy Team

Summary:  The Japanese yen has seen a relentless decline over the last few weeks, underpinned by a widening yield differential between the US and the Japanese government bonds. As verbal interventions from the Bank of Japan and Ministry of Finance fail to be heard, we are looking at a subtle policy shift with the aim to manage volatility, or a real physical intervention.

The JPY continues to run away to the downside, with USDJPY surging above 128.00 for the first time since 2002. The next major chart point is the early 2002 high near at 135.00. AUDJPY has also surged to fresh record highs of 94.50+ as the AUD was slightly firmer following the hawkish tilt in RBA minutes.

The big why?

  • US 10-year treasury yields have notched a new cycle peak and will soon threaten the 3.00% level if they continue to rise, widening the policy divergence with the Bank of Japan (BOJ), that continues to stick with its yield-curve-control (YCC) policy that caps 10-year Japanese government bond yields (JGB) yields at 0.25%.
  • Both the BOJ and the Japanese Ministry of Finance (MoF) have stepped up their verbal interventions against JPY volatility as recently as overnight, but these have hardly had any effect.
  • The BOJ conducted unprecedented four-day purchase plan into the end of its financial year on March 31 after the JGB yields had hit 0.25%, a ceiling the central bank had made clear in March last year. This further highlighted their commitment to capping yields.
  • While the BoJ may be concerned about the volatility and the pace of JPY decline, the Bank is unlikely to be worried about its direction. In fact, BOJ rhetoric repeatedly suggests that it sees JPY weakness as good news for the economy and exports as well as a factor helping to spur imported inflation pressures. This is especially important if we note that GDP is still well below pre-COVID levels and core inflation is negative.

Is inflation a concern?

  • The rise in JGB yields has little to do with expectations that Japanese inflation is moving sustainably higher. CPI is expected to increase above the BOJ’s 2% (from 0.9% currently) target, but the central bank expects the move to be temporary.
  • Much of the gains in inflation are on the back of base effects and higher energy prices, and underlying price pressures remain muted. Stripping out energy prices and fresh food clearly shows that core inflation is still very benign at multiyear lows at -1% y/y.

Will the YCC be tweaked?

  • We are probably starting to see the limit of the yield curve control program, as sustained BOJ purchases could be a problem for a central bank that already owns around half of government issues. Would the BOJ go Australia’s way that clumsily abandoned its peg in November? That would need more domestic demand for JGBs which is unlikely to be achieved.
  • Historically, BoJ has been open to adjusting targeting range of bond yields. It widened the range to +/-0.25% from +/-0.20% in March 2021, which was changed in July 2018 from +/-0.10% before that.
  • The BoJ could tweak its YCC policy to target 10-year yields form +/-25bps to +/-30bps to give itself more flexibility and manage volatility. This move, if effected, will be communicated as a measure to manage the increased volatility in bond markets, to ensure that it is not taken as a sign of any shift in policy thinking.

What to watch next?

  • Our sense is that until a policy shift is spotted, or real intervention is mobilized, the market is content to continue driving the JPY lower.
  • Ironically, in the past, the MoF has mobilised intervention in the yen in the direction of avoiding further JPY strength, not weakness.
  • These interventions may not achieve more than temporary success if the underlying policy and market dynamics don’t shift (i.e., the BOJ sticking to its current policy while inflationary pressures and yields elsewhere continue higher). But the risk of tremendous two-way, intraday volatility should be appreciated.
  • Japan’s Finance Minister Suzuki is heading for a bilateral meeting with the US and comments would be on watch.
  • Next BOJ meeting is scheduled for April 27-28, but focus will still be tilted more towards the Fed’s May meeting where a 50bps rate hike is expected along with the start of quantitative tightening.
  • The only other way could be to hope that the yen would find a floor, and wait for BoJ governor Kuroda’s tenure to end in April 2023. This may then be followed up with rate hikes.

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