With the Japanese yen in freefall and direct FX intervention unable to stop the bleeding, the spotlight is squarely on the Bank of Japan’s upcoming meeting on Friday. While the central bank is expected to revise its inflation forecasts higher, it is unlikely to deliver any meaningful policy changes, keeping the devastated currency under heavy pressure.Â
Yen pain
It has been a painful year for the yen, which has lost a staggering 30% of its value against the US dollar. At the heart of the problem lies the Bank of Japan’s refusal to even consider higher interest rates, in contrast to other major central banks that have been tightening policy at incredible speeds.
With interest rates surging everywhere except for Japan, rate differentials have widened, crushing the yen. Capital is essentially leaving the country, looking for higher returns abroad. The energy shock added fuel to the yen’s depreciation too, by turning Japan’s trade surplus into a deficit, depriving the currency of its main historical advantage.
Direct intervention in the FX market to shore up the sinking yen has been wildly unsuccessful, merely slowing down the pace of depreciation. Traders know that solo intervention without the help of the Americans or Europeans is unlikely to have any lasting impact, as long as the underlying force of interest rates is acting against the yen.
No (real) changes yet
Market participants don’t expect any policy shifts at this meeting either. While inflation has fired up and is currently running at 3%, wage growth and inflation expectations remain muted, reinforcing the BoJ’s view that the current inflation wave is driven mostly by supply factors that will fade away soon.
The only change that is expected is an upward revision of inflation forecasts for the coming years. However, the same ‘sources’ suggest the BoJ will also slash its forecasts for economic growth amid concerns of a global recession, nullifying any speculation about future policy tweaks.
Such an outcome could bring the yen under renewed selling pressure. In this case, dollar/yen could encounter resistance around the 152.00 region.
If there is any shift, it will probably be in tone only. The central bank could adjust its language to indicate it is open to future tightening, which would be a welcome sign but not a game-changer. Such an outcome could spark a short squeeze in the yen, sending dollar/yen down for another test of 146.00.
Big picture
All told, it’s difficult to say where the bottom is for the yen. With the BoJ refusing to play the tightening game and the Fed keeping its foot heavy on the rate increase pedal, there are no fundamental grounds for a trend reversal.
The outlook remains negative and unilateral FX intervention by Japanese authorities won’t change that. Threats of intervention might be enough to chase away some speculators, but they cannot alter economic gravity. Interest rate divergence is the variable that needs to change in this equation to turn dollar/yen around.
There are two ways that can happen – either the BoJ or the Fed have a change of heart. An acceleration in wage growth would be the early signal that a BoJ pivot is coming, while the Fed would need to see a very significant slowdown in inflation. At this stage, neither seems ready to blink.
