The USDJPY fell over 200 pips just before the close on Friday, and has weakened another 200 pips since the new trading week started. The main driver is speculation that the BOJ (Bank of Japan) has intervened in the market, or that there might be coordinated intervention with the Fed in the future to drive down the market. The move comes at a crucial time for the carry trade as it appeared that the BOJ and Fed rates were stabilizing.
Last week, the yen weakened to its lowest level in 18 months, with the USDJPY pair rising to just shy of the 160 handle. Many analysts suggest that’s the rate that would trigger an intervention by the BOJ (Bank of Japan) to shore up the currency. Japan’s currency weakened substantially after Prime Minister Sanae Takaichi called for snap elections last week. Her fiscal policy of high spending to boost the economy is under additional pressure as leading candidates call for tax cuts, which would shrink the nation’s finances.
Rising Japanese Yields Are a Global Problem
Japan has had the lowest interest rates among the major economies for decades, providing a “floor” for global interest rates. This means that if yields on Japanese bonds (JGBs) rise, the rates on other countries’ debt will also come under upward pressure. This is particularly a problem for the US, where the government is focused on lowering yields for various policy reasons.
If investors demand a higher premium to invest in Japanese debt (raise yields), then it will cost more for major economies to pay the interest on their debt. This is a major problem for the BOJ (Bank of Japan), as Japan has the highest debt-to-GDP ratio among advanced countries. If yields rise too much, it could mean the government has less funds available to spend. The US is already facing this problem, with interest payments on debt ranking as the third-largest item in the budget, exceeding defense spending.
Intervening to Get Things In Order
With the BOJ keeping rates unchanged and the Fed also expected to hold off on rate cuts over the next couple of months, the currencies are trading at a relatively stable rate differential. This can attract carry traders, who sell yen to buy dollars and profit from the rate differential. The consequence is a weaker yen, which has a bunch of unwanted effects on the Japanese economy. Therefore, it’s in the interest of both Japan and the US to maintain a stable exchange rate between the two countries, and warn off carry traders from weakening the yen too much.
That’s why the USDJPY cratered late on Friday after the Fed in New York conducted a “rate check”. This is essentially the Fed asking a dealer for the exchange rate, but it’s a powerful tool for the market because it’s the final step before the central bank intervenes. The fact that it was the Fed (which has an infinite capacity to sell dollars, unlike the BOJ (Bank of Japan), which has limited holdings) shook up the market. It means that both Washington and Tokyo are on the same page in keeping rates lower.
Will There Be Intervention
Now that the currency pair has been knocked down substantially (over 4 large handles), the risk of intervention has reduced. Generally, the central bank is looking to “scare” carry traders, since a sudden move in the currency will make their carry trade unprofitable. That keeps the exchange rate more in line with fundamentals and reduces speculative moves.
For now, however, the fundamentals that weaken the yen remain in place, at least until the election. Which means that the pair could reverse course and once again challenge the BOJ and Fed’s willingness to intervene. As a result, there could be another large downward move if the currency rises too high – a fear that monetary policy officials are trying to exploit.
