Overnight, the USDJPY rose to the 144 handle which it hadn’t seen since November of last year. This new weak point in the Japanese currency is just the latest in a long trend that has been going on since April. That’s when markets came to the conclusion that the new head of the BOJ was actually serious about keeping easing policy in place.
But, understanding that the currency is now approaching the levels that last prompted the BOJ to step in, there is a rising question: When will authorities do something to stop the decline in the yen? Technically, it’s actually the Ministry of Finance that steps in to shore up the currency, but it does so by instructing the BOJ to act. So, when will the BOJ do something?
Where the core issue lies
The main problem for Japanese authorities is squaring ultra-low interest rates to shore up the economy with an increasingly weaker currency that threatens to blow up inflation. Japan is facing a problem that it hasn’t had to deal with in a long time, and it might take too long for authorities to adjust to a new reality.
With Japan doubling down on ultra-low rates and other central banks continuing to hike, there is increasing downward pressure on the yen. Carry-trade is now in vogue, where people sell yen and buy other currencies to take advantage of the difference in interest rates. The most effective and permanent way to deal with the problem of a weaker yen would be to get rid of the ultra-low interest rate policy. But, it appears that Japanese authorities are not near to doing that. At least, that’s what the market is betting on, pushing the USDJPY higher and higher.
Something has to break
The last time the currency pushed towards these levels, Japanese officials tried to “jawbone” it down, by saying they were “intensely monitoring” the situation or were “concerned” about the exchange rate. But the currency was allowed to drift above the 150 handle before something was actually done, with the BOJ stepping in on behalf of the Ministry of Finance to buy a relatively small amount of the currency. This helped curtail the free-fall.
But, it wasn’t until the BOJ made the surprise move of widening the band on YCC that things turned around. The BOJ tried to pass the move off as “policy neutral” because it widened the band both into positive and negative. But since all the pressure was on the upside, in practice it was a move towards tightening. It was also seen as the first step that would be taken to get rid of YCC, which is an easing mechanism. After that, the next step would be moving towards tightening, either with an interest rate hike or slowing down the amount of bonds being bought.
When will it happen this time around?
The issue now is that widening of the YCC already happened, so the BOJ doesn’t have that tool at its disposal. Presumably it could widen the range again, but the effect might not be as pronounced, as investors might not be convinced it’s a credible move towards tightening. The other option would be joint intervention between the Fed and the BOJ, something that Japanese authorities have hinted at with talk of “coordination”.
In the end, however, it seems that Ueda is favorably disposed towards tightening – just not yet. The position of the BOJ might be to try to hold the line until the next GDP reading, to see if growth is actually manifesting. In the end, the whole point of the easing is to get “organic” inflation, not inflation caused by higher import costs from a weak currency. The question is whether the market will force Ueda to make his move ahead of schedule.
