The yen has been fluctuating widely recently, amid significant shifts in expectations for the BOJ. Markets are concerned about a potential disconnect between monetary policy and the more aggressive stimulus stance from the new Prime Minister. Beyond that, however, Japan is teetering on a mountain of debt that could cause major currency moves if not handled correctly.
The USDJPY crashed below the 155 handle on Monday, only to reverse back above 156 the following day. The big moves are somewhat unusual for the normally steady yen, which has a reputation as a safe-haven. However, some recent moves could challenge the market’s perception of the currency, potentially affecting how the currency pair evolves through the end of the year.
What Moved the USDJPY on Monday?
The proximate event that prompted the yen to strengthen suddenly on Monday was comments from BOJ Governor Kazuo Ueda, which the market interpreted as signalling an imminent rate hike. Up until Sunday, futures were pricing in a less than 50% chance of a BOJ rate hike in December.
Ueda’s comments were not out of the ordinary. In fact, they largely reiterated his prior stance that the BOJ would hike if the data merited it. This is typical rhetoric for a central bank that is facing inflation above target. What surprised markets, actually, was that he didn’t shift to a more dovish stance. Apparently, many traders were assuming that PM Sanae Takaichi’s dovish rhetoric would translate into similar comments from Ueda. That was part of the reason the yen had been weaker lately, as the market pushed forward its rate-cut hopes to next year.
Why the Sudden Rebound?
For most of November, the yen had weakened against the dollar, prompting warnings from prominent Japanese policymakers. They implicitly threatened to intervene in the Forex market to push down the currency pair that they saw was rising too fast. However, over the last couple of weeks, the USDJPY has been cooperating and continued to back off of its November highs.
So, a particularly hawkish stance from Ueda seemed a bit out of place, and could signal that the BOJ is more likely to raise rates than the market had anticipated. It also left markets a little discombobulated, given the Ministry of Finance’s otherwise dovish stance. Given the uncertainty, markets shifted their outlook, leading to a dip in USDJPY. Early Tuesday, Takaichi reiterated the importance of coordination between the BOJ and the government, helping to calm markets as well.
The JGB Problem
One concern for traders was a rise in Japanese government bond (JGB) yields, which could pose a significant problem for the Japanese economy. The country’s high level of debt makes it vulnerable to ‘deficit hawks’, who can push down bond prices amid concerns the government won’t be able to pay off its debt. In that case, it could cause financial institutions to lose a lot of money, given how many own large amounts of long-term Japanese debt.
This is why the BOJ has to be exceptionally careful when raising rates, because it could trigger a financial crisis if long-term yields rise too fast. An auction of Japanese debt on Tuesday has strong buyer interest, which helped lower yields and reassure markets. But, the incident shows that the yen is increasingly vulnerable to fluctuations in JGB yields.
