When the BOJ raised rates last month, it was natural to presume that the yen would get stronger, reflecting expectations for Yen strength in response to interest rate hikes. That’s what normally happens to currencies when interest rates go up. But, Japan has a unique system in a unique situation. Which means that the currency often behaves counterintuitively, and this is one of those cases.
Mind you, that doesn’t mean that the conventional wisdom that higher rates will lead to the yen to strengthen at some point down the road is wrong. It’s just that there are some issues to get through, first. The big question now is whether those issues are big enough so that the BOJ will be forced to step in to prop up the yen.
Where it Went “Wrong”
Before the BOJ did its historic move of exiting negative rates (and being the last major central bank to do so), there was a lot of speculation about what would happen. Traders pared back their exposure in case there was a strong reaction. When that didn’t happen, the risk event of the BOJ meeting was over, and traders could jump back in. That pushed the USDJPY higher.
The thing is, BOJ governor Kazuo Ueda had spent months signaling that even when rates went up, they wouldn’t go up fast. The BOJ would remain very, very accommodative. In that line, it didn’t give up its JBG buying program. That meant that even though it got rid of yield curve control, it would still keep Japanese bond yields really low.
The Difference that Matters
It’s the relative difference in bond yields that drives currency moves, as a wide enough gap makes carry trading profitable. And that was what led to the weakness in the yen in the first place: Traders selling yen at a low interest rate to buy other currencies such as the dollar at higher rates.
Even after the BOJ raised rates, the difference in interest rate between US treasuries and JGBs was around 350 bps. That is plenty attractive enough to keep carry trading. What would end this situation is if the interest rate cap closed substantially, with the Fed cutting rates and the BOJ hiking. But the current market expectations are for that not to happen.
The Gap Isn’t Expected to Close
At the start of the year, the Fed was expected to cut rates six times, which weakened the dollar. But through the course of March, that was revised to expecting only three cuts. That contributed to a rise in US interest rates. Meanwhile, the BOJ is forecast to keep rates at the current level at least until next year. Which means there isn’t much prospect in the short term that the gap that is driving the weakness in the yen will narrow significantly any time soon, affecting Yen strength.
But, that doesn’t mean it won’t narrow eventually. The problem for Japanese authorities is that if they intervene too hard now, then they could have the exact opposite problem in a few months when the carry trades unravel as interest rates normalize. Carry traders would have to buy back yen to close out their trades, which could cause a harsh swing in the other direction. So, it might be just that officials in Tokyo are trying to buy time until June or July for when the Fed does get around to cutting rates, and that could finally relieve pressure on the yen.
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- Source: https://www.orbex.com/blog/en/2024/04/why-isnt-the-yen-getting-stronger
