In mid-March 2024, the Bank of Japan made two important decisions: first, it ended the negative interest rate policy that had lasted for more than a decade since 2007 and raised the benchmark interest rate from -0.1% to 0-0.1%; The second is the abolition of another ultra-loose monetary policy that has lasted for eight years since 2016, known as the "yield curve control policy" (YCC policy). It is worth noting that these two moves have not changed the decline in the yen's exchange rate, which has depreciated by about 50% against the dollar since the Fed started raising interest rates in 2022, which has caused a big shock to the Japanese economy, which relies on imports.
A source of exchange rate fluctuations
As for the reasons for the failure of the yen exchange rate to stabilize, it is necessary to analyze the monetary policy itself. Negative interest rates are relatively easy to understand, while YCC policies are a bit more complicated. Yield curve control is a monetary policy tool used by central banks to manage interest rates on government bonds of different maturities, setting specific yields or interest rates on government bonds of different maturities, usually with the aim of keeping long-term interest rates at ideal levels. The specific working principle is to intervene in the bond market by the central bank to buy Treasury bonds, so that the yield of Treasury bonds is close to the expected level. Prior to the March adjustment, the Bank of Japan set a target of 0% for the 10-year JGB yield.
There is a negative correlation between bond prices and bond yields, and when participants in the bond market sell bonds, the price of such bonds decreases, and the corresponding bond yields increase. Therefore, when Japan's YCC policy sets the target of Japan's 10-year government bond yield at 0%, it means that whenever Japanese long-term government bonds are sold in the bond market, the Bank of Japan will step in and buy these government bond sell orders in unlimited quantities until the 10-year government bond yield returns to the level of around 0.
While the YCC policy continues to inject liquidity into the Japanese economy, it also strengthens the yen's international status as a safe-haven currency: international investors can continue to buy long-term Japanese government bonds when the yen depreciates, and can sell these government bonds when the yen appreciates, without worrying about the price drop caused by the sell-off, and transfer all the pressure to the Bank of Japan; The Bank of Japan (BOJ) has provided financial capital with a near-capital-guaranteed approach in exchange for the yen's current international liquidity.
Pointing to avoid the depreciation of the dollar?
The core benefits of the yen as a safe-haven currency are reflected in the exchange rate differential. With the cyclical adjustment of the Federal Reserve's monetary policy, the US dollar has been cyclically appreciating and depreciating, while the interest rate of the US dollar against the yen has maintained a relatively large elasticity for a long time, and the yen's reaction to the appreciation and depreciation of the US dollar is more drastic than that of other major currencies in circulation. The wide interest rate differential, coupled with the unlimited guarantee of the central bank on the price of Japanese long-term government bonds provided by the YCC policy, makes the yen not so much an international safe-haven currency, but more accurate, the yen is the best currency to avoid the depreciation of the dollar, and the Japanese long-term government bonds are the best safe haven for international capital when the dollar depreciates.
In the adjustment of Japan's monetary policy in March this year, the Bank of Japan abolished the YCC policy and no longer set a reference value for long-term interest rates, in other words, the Bank of Japan no longer provides a guarantee for the price of Japanese long-term government bonds. Looking back at the adjustment process of Japan's YCC policy in the past, it can be seen that the Bank of Japan has consciously and gradually paved the way for withdrawal, and the pace of adjustment has accelerated since 2022, accompanied by the rapid appreciation of the US dollar after raising interest rates, which eventually led to the continuous depreciation of the yen in this round.
The end of Japan's YCC policy is a foregone conclusion, and as for the future of the yen, it is likely that it will be difficult for the yen to reverse the long-term depreciation trend until the Fed actually starts cutting interest rates, or until the Fed stops shrinking its balance sheet and shifts to balance sheet expansion.
In addition, it will take longer to observe the extent to which international capital will continue to use the yen as a safe haven after losing the backing guarantee, whether the yen's status as an international currency will decline as a result, and the direction of the Japanese economy after moving away from negative interest rates, given that the local economy has been accustomed to a negative interest rate environment for many years.