The weakening of the Japanese yen (-10% against US dollar since the start of the year) can be explained by two factors: 1) The downward revision of global growth as Japan is seen by investors as a very leveraged markets in the world economy); 2) The widening gap between US Treasury yields and JGBsthe Japanese equivalent. Indeed, the US Federal reserve is on its way to normalize its monetary policy through rate hikes and a potential reduction of the size of its balance sheet. Meanwhile, Japan continues to pursue a dovish monetary policy and consider yield curve control (YCC) to prevent any rise of the long-end the JGBs yield curve. And this despite the fact that Japan’s CPI is also on the rise. This widening yield gap is putting downward pressure on the Japanese yen which is now trading at a two- decade low against the greenback.
On a global scale, the downside risk of a weaker yen could lead to competitive currency devaluations in the rest Asia including the Chinese Yuan. And there could be some ripple effects such as further weakening of the euro and the risk of an emerging markets crisis due to the strong dollar.
A weaker yen is also an issue for Japan which is a huge commodity importer. Resource-poor Japan has seen its trade deficit hit a 8-year high in March as commodities denominated in Yen have increased by 50% since the start of the year. Japan depends overwhelmingly on fossil-fuel imports to meet its energy needs and soaring oil and LNG prices are starting to hurt both businesses and consumers.
As the USD/JPY enters the 127-130 range, the odds of direct forex intervention and/or for the Bank of Japan (BoJ) to abandon its bond yield target are rising. But history shows that intervention rarely delivers their policy objective of changing the trend in the currency. And this week’s announcement by the BoJ doesn’t seem to go into this direction (see below).
As highlighted in a recent Reuters article, traders’ positioning data shows long dollar/yen positions have built to a three-and-a-half year high but are short of the peaks achieved in 2017, 2013 and 2007. This suggests that there is room for investors to keep selling for longer. Neither Japanese retail long positions in yen nor foreign speculative short positions have kept pace with the speed of the yen's selloff, according to J.P. Morgan FX strategist.
We will thus continue to monitor the USD/Yen move very closely. At our last Asset Allocation meeting, we downgraded our view on the Yen to cautious. We are currently hedged on the Yen in our discretionary accounts. On the equity side, note that the weakening of the yen is a tailwind for Japanese exporters.