By Joseph Moss, International Banker
On October 25, the yen breached the key psychological threshold of 150 against the US dollar for the first time since 1990. After market expectations of firmer actions by the Bank of Japan (BoJ) to lift its yield curve control (YCC) policy were scuppered one week later, with Japan’s currency continuing to weaken further into November, questions are justifiably being raised about how low Japan’s currency can go over the coming months.
The yen’s continued depreciation comes in the wake of the BoJ’s policy board’s October 31 announcement that it would allow its 10-year government bond’s yield to rise above 1 percent, thus relaxing its previous strict policy of yield curve control for the second time in only three months. In July, the central bank stated that while it was not ready to allow bond yields to trade freely, it would allow yields to rise to 1 percent from its previous upper limit of 0.5 percent, mainly through offering to buy 10-year bonds at 1 percent in fixed-rate operations.
The October meeting extended this policy to above 1 percent, thus promptly triggering the 10-year JGB (Japanese government bond) yield to climb to a 10-year high above 0.95 percent in early November. “The Bank will regard the upper bound of 1.0 percent for 10-year JGB yields as a reference in its market operations, and in order to encourage the formation of a yield curve that is consistent with the above guideline for market operations, it will continue with large-scale JGB purchases and make nimble responses for each maturity,” the BoJ’s statement following its October 31 meeting read, omitting any mention of “consecutive unlimited fixed-rate purchases of JGBs”, thus suggesting that a more flexible approach towards interest rates was being adopted.
Normally, such a policy would support a stronger yen, given that the higher rates of return resulting from the BoJ’s actions would likely trigger more demand for Japan’s currency. However, reports suggest that the market anticipated a much firmer abandonment of yield curve control than was ultimately delivered on October 31. “The yen strengthened after last night’s Nikkei news report, but there was nothing more in today’s BOJ announcement than what was reported. Some investors had hoped for an increase in the upper limit of the 10-year JGB yields to 1.5%, for instance,” Kengo Shiroyama, a strategist at Daiwa Securities, told Nikkei Asia. “However, the BOJ’s policy decision was not only aimed at correcting the yen’s weakness. It was a comprehensive decision aimed also at improving the functionality of JGB operations.”
The interest-rate spread between the United States and Japan has continued to widen as the Federal Reserve’s (the Fed’s) “higher for longer” regime stands in stark contrast to Tokyo’s continuing ultra-accommodative monetary policy; long-term US interest rates adjusted for expected inflation now stand at around 2.5 percent, while they remain firmly in negative territory in Japan. Thus, the yen may remain on a downward trend against the dollar well into 2024. Indeed, there is enough hawkish sentiment among US policymakers to suggest further rate hikes will be required to bring inflation down to their 2-percent target, with the Federal Reserve Bank of Minneapolis’s president, Neel Kashkari, recently confirming to the Wall Street Journal that he would err on the side of overtightening monetary policy to do so. “Undertightening will not get us back to 2% in a reasonable time,” Kashkari said, adding that more information is needed to reach firm conclusions on interest-rate decisions. “I am not ready to say we are in a good place.”
But it’s not simply the dollar against which the yen continues to decline. Early November saw the 161 mark reached versus the euro (the yen’s weakest showing against the eurozone’s single currency since 2008) and the 111 position against the Singapore dollar, a level last seen in 1985. “Non-dollar currencies, which are less likely to face intervention, are being paired for yen selling,” according to Daisaku Ueno, chief foreign exchange strategist at Mitsubishi UFJ Morgan Stanley Securities.
So, should yield curve control be fully eliminated to rescue the yen? Some analysts believe the central bank’s recent moves to lift the 10-year JGB yield point to the impending death of this controversial policy, even if it continues to conduct fixed-bond purchases. “The formal end of the YCC will be more of a ceremony,” Daiwa Securities’ strategist Kazuya Sato told the Financial Times on November 3, adding that the ending might be realised as soon as December. “I think the BoJ has managed to begin a gradual path towards normalisation without creating too much market impact.” That said, the BoJ’s governor, Kazuo Ueda, recently noted that he doesn’t expect yields to rise “significantly above the upper limit” and certainly not into the 1.5-to-2-percent range. “Our projection is that 10-year yields will not stay much above 1 percent on a sustained basis, given that we intend to conduct large-scale JGB purchases as necessary and carry out unlimited fixed-rate buying operations in some cases,” Ueda said.
While some welcome the BoJ’s incremental relaxation of the yield curve as a positive move towards ending its ultra-expansionary monetary policy, others wait for it to lift its short-term policy rate—and crucially, remove it from negative territory, with its current standing at -0.1 percent. “Market players are looking beyond the YCC,” according to Yuji Saito, senior adviser at the Tokyo branch of Crédit Agricole Corporate and Investment Bank (Crédit Agricole CIB). “The statement didn’t give any indication of the BOJ exiting from its negative interest rate policy.”
There is considerable optimism for a rate hike to transpire next year, however. “Over the past three months, the market has now priced for not only the exit of negative interest rates but for a full interest rate hike next year,” Steve Donzé, deputy head of investment and products at Pictet Asset Management Japan, told the Financial Times on November 8, adding that the first rate hike will materialise in January. UBS, meanwhile, has pencilled in the first rate increase for April, with Goldman Sachs predicting it for next October. Additionally, the central bank raised its median core-inflation projections (excluding fresh-food prices) from 2.5 percent to 2.8 percent for the fiscal year (FY) ending March 2024; if fulfilled, inflation will remain above the BoJ target of 2 percent for a third consecutive year, and pressure may grow to normalise short-term interest rates sooner rather than later.
But with Japan’s rate trajectory standing at distinct odds with those of many leading central banks’ monetary policies, one can reasonably assume that no significant yen appreciation will transpire anytime soon. “Based on BOJ Governor Kazuo Ueda’s comments on Monday, there are many views that the low-interest-rate policy will continue for the time being,” Rikiya Takebe, senior strategist at Okasan Securities, explained to Nikkei Asia on November 8. “If the focus is on interest rate differentials, there is no reason to buy the yen.”
The impacts of a persistently weak currency will thus continue to have a polarising impact on key industries. For instance, with the yen weakening by around 10 percent since December 2022, Tokyo has been forced to scale down its military-spending plans. Last year, a five-year, 43.5-trillion-yen defence strategy was initially on the table, based on the exchange rate of 108 yen per dollar in the summer of 2021, when the plan was first devised. But three government officials with direct knowledge of defence procurement and five industry sources told Reuters in early November that significant yen weakness was directly responsible for anticipated major cutbacks in aircraft purchases in 2024, the second year of the buildup. And unlike large companies with overseas business operations, Japan’s Ministry of Defense does not hedge against currency risks, one government official confirmed, so it cannot protect itself against the rising costs in yen of Tomahawk cruise missiles and F-35 stealth fighters.
Of course, those large companies that do have significant business operations overseas have prospered greatly from the yen’s depreciation, with exporters seeing their overseas earnings balloon when they are converted back into yen in many cases. Nissan, for example, reported a tenfold growth in profits for the July-September quarter from a year earlier, attributing the surge to the weak yen and strong global vehicle sales. The Japanese automaker reported a 190.7-billion-yen (US$1.3 billion) profit for the quarter, compared with 17.4 billion yen the year before, with quarterly sales swelling by 25 percent to 3.15 trillion yen ($20.9 billion). It has also raised its full fiscal-year profit forecast through March 2024 to 390 billion yen ($2.6 billion) from its earlier estimate of 340 billion yen ($2.3 billion).