- Yen weakness persists despite strong current account surplus and narrower US-Japan rate spreads.
- Japan’s reflation, and buoyant exports and markets have not revived the JPY.
- Fiscal stimulus, energy costs, and cautious BoJ policy continue to weigh on the yen.
- US motive may be avoiding Treasury sales by Japan, using FIMA as a short-term buffer.
- But this would compound Fed’s operational challenges.
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COMMENTARY: Yen matters
The early-August Japan-US coordinated intervention to prop up the chronically weak Japanese yen was striking in its ambition but unclear in its scope and motivation. Was it done to help Japan, or the US? What is the likelihood of success of such a rare move?
While the yen has depreciated, in real effective terms, by 35% during this decade, it has hardly been volatile lately, by historical standards. Japan’s current account surplus, registering an above-trend 4-5% of GDP lately, ought to be causing the yen to appreciate, but that hasn’t been the case. A gradual narrowing of policy rate differential with the US, from 5.6% to 2.75% over the last 24 months, should pave the way for yen strength, but to no avail.
Japan has finally come out of a few decades of debt-deflation crisis, enjoying a period of reflation that has helped address its debt burden substantially. Led by the electronics sector, exports are doing well. Capital markets have turned buoyant. But even these bouts of positive developments have not led to exchange rate appreciation, vexing some observers.
Perhaps the interest rate spread vis-à-vis the US dollar needs to narrow further, perhaps more market friendly measures are needed to bring back resident flows to Japan. The current administration’s push to boost fiscal spending, the soaring cost of energy imports, and a rather conservative reaction function of the Bank of Japan have not helped the yen’s cause either. All these measures, if they are corrected, could help the yen in a substantive manner.
We will dismiss the argument that the US engaged in the intervention to help stabilise Asian currencies, which were supposedly at risk of facing a contagion of depreciation pressure. Some Asian currencies have faced selloff pressure this year due to the rising cost of importing energy, and some currencies have weakened due to capital flowing toward the US stock market, none of which have anything to do with the yen.
We will also reserve judgment that the Japanese were running out of ammunition to defend the yen, given the nation’s multi-trillion dollar holding of foreign assets. They did not need a helping hand from the US Treasury, in our view. From outright intervention to fiscal consolidation to policy rate increases, Japan has plenty of credible tools to prevent further slide of the yen.
Our view is that the motivation was to support US bond yields. Already under selling pressure due to Fed rate hike expectations, well above-target inflation, and large bond issuance pipeline, the last thing the US needed was for the largest foreign holder of US treasuries to start selling them to get the cash needed for intervention.
The fact that the US treasury is urging the Federal Reserve to increase the capacity of its Foreign and International Monetary Authorities Repurchase Facility (FIMA) speaks volumes. Japan can use its holdings of US Treasury securities as collateral to obtain dollars through FIMA, instead of selling the bonds outright.
The intervention’s impact thus far has been a 10bps narrowing of short-term US-Japan rates differential, which ought to be yen positive. The yen however has gained just 0.5% against the USD, way too little to make a difference to the officials in Washington DC.
Using the FIMA swaps as opposed to outright selling could, in the near term, reduce the risk of a jump in treasury yields. But if the yen appreciated a great deal, it would in turn make JGBs more attractive and cause Japanese investors sell US bonds in any case. That might in turn require even more intervention to support US bonds. The US Treasury’s keenness to put a short-term palliative on the bond market may well have delayed eventual pain, while imposing additional operational complexity on the Federal Reserve, in our view.
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