Yen currency intervention in the short term
The Bank of Japan might consider intervening in the market to address the yen’s declining strength. However, in the end, it is contingent upon the actions of the Federal Reserve.
Officials in Tokyo are facing a challenging dilemma, just like their counterparts in Wall Street and Washington.
The unexpected rise in U.S. inflation has caused a shift in expectations regarding the Federal Reserve’s potential interest rate cuts for this year. This has caused significant effects on the Pacific region, leading to the Japanese yen reaching its lowest value against the dollar in almost 34 years and creating a challenging situation for the country’s central bank.
The disparity in countries’ bond yields plays a significant role in influencing the foreign-exchange market dynamics. This factor sheds light on the reason behind the yen’s depreciation by one-third since the conclusion of 2020. With the recent increase in interest rates, the Bank of Japan is now confronted with a challenging decision. Should they opt for a more rapid tightening to counteract the decline of the yen, or should they maintain their current position? Japanese government officials have recently shown concern about the yen’s significant decline.
A potential option might be to consider implementing a temporary solution that could serve as a short-term fix, albeit at a higher cost due to the necessary intervention. Japan allocated a substantial amount of funds, approximately $60 billion, to bolster the yen during 2022, as the currency maintained a value of around 150 in relation to the dollar. The currency experienced a temporary recovery in the subsequent months, only to continue its decline thereafter.
Since the start of February, there has been a 0.56 percentage point increase in the yield gap between 2-year government bonds of the U.S. and Japan. This can be attributed solely to the rise in U.S. yields. Japanese yields have experienced an increase of 0.18 percentage point during the period.
In the short term, a currency intervention may provide support for the yen. However, it is important to consider that interest-rate differentials will ultimately determine the long-term exchange rate. Earlier this year, there was anticipation in the market that the convergence of interest rates between the U.S. and Japan might have a positive impact on the yen. Although the Bank of Japan did increase rates, it refrained from providing any insight into the trajectory of future hikes.
The Bank of Japan has been cautious about increasing rates at a rapid pace. It maintained its negative interest-rate regime over the past few years while many other major central banks were increasing them. It has the option to take matters into its own hands and permit its bond yields to increase. While the Federal Reserve is reducing its bondholdings, the Bank of Japan remains an active buyer. However, in a country where the government has accumulated significant debt and businesses and individuals have grown accustomed to low interest rates, this could have a disruptive impact on both public and private finances.
There is a potential concern that a depreciating yen may lead to an increase in inflation in Japan, as it would raise the expenses associated with the country’s significant food and energy imports. However, after many years of deflation, the Bank of Japan has also demonstrated a willingness to accept and accommodate this situation. Japan’s headline inflation rate experienced a decline from 4.3% in January last year to 2.8% in February.
Similar to many economists on Wall Street and investors worldwide, officials in Tokyo had anticipated several U.S. cuts to provide assistance this year. It appears increasingly probable that assistance will not be forthcoming in the near future. That would imply a continued decline in the value of the yen, leading to increased inflation in a country that is unaccustomed to such circumstances.
