The weakening yen is unpopular in Japan and pressure is mounting on politicians for action but there are no easy answers. I spoke with BNNBloomberg about the issues:
1) Rate differentials are the driver. You can buy a 10-year Japanese government bond and get 0.9% per year or buy a US 10 and get 4.7%. Add in the weakening currency and there is a tidal wave of money chasing this trade, which is a classic carry trade.
2) Intervention is an option but the long history of intervention shows that it only helps when fundamentals are improving. The Japanese government – which order the intervention – waved a bit of a white flag this week in saying that it wasn’t currently weighing intervention. That was a blunder because it gave the market the green light to push further.
3) There was some hesitancy to push the yen lower ahead of the Bank of Japan. In March they hiked rates for the first time in 17 years and there was some angst they could tee up another move but the decision was benign. They laid out an indeterminate timeline on hiking if economic forecasts unfold as they hope.
4) Inflation isn’t rising. Somehow Japan avoided the inflationary perfect storm that hit the rest of the world and now prices are moderating. Today Tokyo reported CPI at 1.6% compared to 2.2% expected. Now the miss was largely due to a one-off change to high school tuition rates and the market picked up on that but it’s a headline that won’t boost inflation expectations.
So what are the options? The Japanese government can spend more to boost growth but that’s hasn’t worked and the country is enormously indebted. There have been some positive wage indications this spring but those will take 2-3 years to become ingrained and hiking now would send the wrong signal.
So the relief valve is the currency and it’s tough to see a floor.
What Japan – and much of the world – is hoping for is a turn in the US dollar and global inflation. If other central banks begin cutting then those rate differentials narrow. Alternatively, if a recession looks like it’s on the horizon, there will be a surge in the yen.
With a carry trade, the money moves steadily and slowly but when there is trouble, it’s a race to the exits. Back just before the financial crisis, there was this same dynamic and money was flowing into the high-yielding AUD and NZD it unwound at breakneck pace, including days with 10% currency moves.
But all they can do right now is wait.
What's driving the US dollar side of the trade
The dollar bid right now is driven by inflation fears and specifically the fear that the Fed will have to hike again. I think we’re close to the point of maximum pessimism on that front.
The market initially focused on this week’s US inflation numbers – which were hot – but eventually pivoted to focusing on growth. If you look at good’s prices, they’re flat y/y and Wal-Mart on Thursday emphasized that and was even talking about lowering meat and vegetable prices.
The US government is also running a deficit at 7% of GDP (compared to 1.4% in Canada). I think the US dollar ultimately turns when the fiscal belt tightens, which isn’t going to be until late 2025 at the earliest, though maybe the market starts to price it in after the election, depending on the results.
