By Wei Hongxu*
The depreciation of the Japanese yen has recently been attracting wide attention. With the yen softened to JPY 120 against the dollar, the Bank of Japan (BoJ) offered to buy unlimited amounts of 10-year Japanese government bonds (JGBs) at 0.25% on March 28, stepping into the market to defend its implicit yield cap for the second time in the year.
The move came after the 10-year JGB yield crept up to a six-year high of 0.245% in early trade, just a half of a basis point shy of the BoJ’s tolerance ceiling under its yield curve control policy. There is no doubt that BoJ’s move would further exacerbate the depreciation of the yen. That saw the dollar scale a fresh six-year peak of 123.03 yen, giving it a gain of 6.9% for the month. The Japanese currency fell as low as 124.81 at one point, nearing the JPY 125 mark. Meanwhile, the ailing euro rose 4% on the yen this month to 134.56. The euro has misplaced about 2.3% on the greenback in the identical interval, however at USD 1.0954 it is above the current two-year trough of USD 1.0804.
The fall in the yen has kept the U.S. dollar index to 99.098, up 2.5% for the month. The yen has been weakening recently with the fallout from the Russia-Ukraine conflict blighting currency markets, and has fallen close to 6% this year, the worst-performing G10. Researchers at ANBOUND pointed out that, as the Japanese currency continues to depreciate, the risk posed by this cannot be overlook. Furthermore, the fluctuations in the yen may cause changes, not only in the evolution of currency market structure, but also recalls the turbulence brought by the depreciation of the Japanese currency to Southeast Asian countries and other emerging markets. All in all, this is more likely to bring about profound changes in the global financial and monetary systems.
Most market players believe it is mainly due to the difference between the BoJ’s continued to take a persistent stance when it comes to monetary easing, and the Federal Reserve intensively tightening its monetary policy stance. United States 10-year Treasuries yields jumped 33 basis points last week and are up a staggering 67% basis points on the month at 2.49%. The rapid boost in the dollar index and the sustained rise of bond yields have fundamentally changed the global zero interest rates monetary environment under the pandemic, bringing increasing pressure to the Japanese currency, which continues to push for quantitative easing. More market traders have also been aware that the current situation of the yen has essentially changed compared to pre-pandemic levels. The high level of inflation in Europe and the U.S. has led to accelerated interest rate hikes in the U.S. against the dollar, which has also prompted the European Central Bank to ease back, ready to begin “tapering”. Meanwhile, emerging markets such as Brazil have already raised interest rates repeatedly to bring inflation down.
With the deflation trends, the continued easing of the yen is certainly under fire, increasing the trend toward “risk-free” currency arbitrage. This has broken the balance of borrowing yen to invest in the U.S. capital market, and returning the yen with profits. The changes here indicate that the yen is losing its role as a safe-haven currency in a low-interest-rate environment.
Some market analysis believes that those funds taking advantage of the zero-interest-rate arbitrage of the yen are basically unwinding positions, and the reliability of the yen as a global safe-haven currency is gradually declining. Instead, it has become a barometer of investors’ views on interest rates. Therefore, ANBOUND researchers believe that the yen may fall into a vicious cycle of sustained depreciation if the BoJ policy remains unchanged in the case that the previous equilibrium has broken.
However, both the BoJ and the government remain adamant that a “moderate” depreciation of the Japanese currency will help in strengthen exports and lift inflation to its 2% target. As things stand, Japan has been running a trade deficit for months on the back of rising energy and commodity prices, as the yen has continued to depreciate since last year. The depreciation of the yen is further fueling imported inflation, raising costs for companies and households, which is not conducive to enhancing Japan’s export competitiveness.
In addition, Kyodo News stated that the interest rate gap between Japan and the U.S. is expanding. There are also supply constraints caused by the impact of higher resource prices. With Japan’s current account deficit and long-term concerns about the yen, investors have begun a positioning strategy of betting its currency will depreciate further against the dollar. In this case, the BoJ is more likely to lose control of its inflation target soon. In terms of capital flows, once the market has a consensus expectation of the persistence of yen depreciation, not only will overseas funds be withdrawn, but they will also cause an outflow of domestic capital.
Although the BoJ can continue to provide ample liquidity, the Japanese market, which loses investment value, will face a negative cycle of capital outflow and market fall, leading to a vicious depreciation of the yen in the short term. In fact, the BoJ’s sustained easing policy has not achieved its goal of boosting the domestic economy but has resulted in as much as USD 10 trillion of overseas investment. Whether the depreciation of the yen can bring the return of overseas funds remains to be observed. In the absence of changes in Japan’s domestic economic structure, it is more likely that funds will persist in outflowing to overseas markets. This will not have the effect of monetary easing on the Japanese economy but is more likely to trigger a new crisis due to the turmoil in the capital market.
What is even more worrying is that if the turmoil caused by this round of depreciation continues, the exchange rate risks may spread to Southeast Asia and other emerging market countries with close economic and trade ties. In the context of global currency contraction and intensified geopolitical risks, emerging markets have already faced the pressure of capital outflow and exchange rate depreciation, and funds have been persistently flowing out of emerging markets. The situation is more complex than the crisis in 1997, and the possibility of a broader conjuncture is building up.
In the case that the yen keeps depreciating and gradually loses its role as a safe-haven currency, its more profound impact lies in the evolution of the international financial system and currency landscape. In a globalized financial market, the yen has been used as a safe-haven currency for a long time due to the size of the Japanese economy, has become a currency asset allocated by international investors. In the context of intensifying geopolitical risks and increasingly evident differences in monetary policies of various countries, not only the long-term position of the U.S. dollar is being challenged, but other major currencies are also in the midst of the game of change.
Goldman Sachs has previously mentioned that the world is now undergoing a “paradigm shift” from globalization to regionalization. With the trend, capital faces the embarrassment of having nowhere to go, and some traditional “hedge markets” are difficult to play a role, which further promotes the reconstruction of the international capital market and the trend of capital returning to localization. The volatilities of the yen reflect the changes and are also pushing it further towards geopolitics.
*Wei Hongxu, A researcher at ANBOUND, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham, UK