Nichigen Rhapsody! Japan Central Gyoku Ide

The yen continued to weaken against the dollar, and the Bank of Japan made a rare move to reduce the scale of Japanese government bond purchases.

On May 13, local time, the Bank of Japan cut the amount of government bond purchases, reducing the purchase amount of 5-10 year Japanese government bonds from 475 billion yen to 425 billion yen.

This is the first time that the Bank of Japan has reduced the size of its government bond purchases since the end of December 2023.

Mitsubishi UFJ Morgan Stanley Securities Co. commented that the Bank of Japan's reduction in the scale of Japanese government bond purchases was unexpected. It's hard not to see this tapering as a response to the recent depreciation of the yen. More volatility is likely to occur in the bond market.

Immediately after the decision, Japan's benchmark 10-year government bond yield rose, while the yen began to recoup earlier losses.

The Japanese government intervened in the exchange rate

Since the beginning of 2024, the U.S. dollar index has fluctuated higher, major non-U.S. currencies have generally weakened, and the yen has also continued to weaken against the dollar.

At the end of April, the exchange rate of the US dollar against the yen once rose above the 160 mark, and the yen exchange rate depreciated to a new low in 34 years, depreciating by more than 10% during the year. There have been many predictions that the Japanese authorities will intervene in the exchange rate.

Foreign exchange intervention by the Japanese authorities is usually decided by the Ministry of Finance and implemented by the Bank of Japan. On April 29, although Japan's Ministry of Finance did not reply in the morning on whether to intervene in the exchange rate, Japan's Vice Minister of Finance Masato Kanda said in the afternoon that it would continue to take appropriate measures to deal with excessive foreign exchange fluctuations, and announced whether it would intervene at the end of May.

The market believes that the Japanese authorities may have carried out two foreign exchange interventions on April 29 and May 2 to temporarily free the yen from its rapid decline. On May 3, the yen briefly broke above the 152 yen per dollar level, but since then the gains have gradually retracted.

Hedge funds sharply trimmed their short bets on the yen after the Japanese authorities came to a "bailout", the biggest drop since March 2020.

According to the latest data released by the U.S. Commodity Futures Trading Commission (CFTC), international leveraged investors held more than 81,000 contracts related to bets on the yen to fall in the week ended May 7, a decrease of nearly 27,000 contracts from the previous week and the largest decline in more than four years.

Yang Aozheng, chief Chinese market analyst at FXTM, told the International Financial News that the continued weakness of the yen is good for exports and investment demand, but the rapid depreciation will lead to imported inflation, both production enterprises and individuals will be affected by import inflation, and find ways to reduce costs or reduce expenses, enterprises need to pass on the cost to consumers through price increases, if consumption power fails to catch up with imported inflation, it will eventually cause retail contraction, corporate profits down, and the economy will not increase but retreat. Externally, the volatility and confidence risks caused by the continuous depreciation of the yen will lead to the weakening of the stability of monetary policy and the credibility of the Bank of Japan, and even worse, the problem of central banks such as Turkey and Argentina losing control of their exchange rates and no longer being able to use monetary policy adjustment control.

Monetary policy may be effective in the short term

On May 8, Bank of Japan Governor Kazuo Ueda said that a rapid and unilateral decline in the yen is not good for the Japanese economy and is undesirable, and that monetary policy measures may be taken in response to fluctuations in the foreign exchange market.

On 13 May, the Bank of Japan (BOJ) cut government bond purchases, which was seen as another move by the Japanese authorities to "save the yen".

Market analysis points out that the yield difference between the debt of Japan and other countries, especially the United States, is an important factor affecting the yen exchange rate. The Bank of Japan's reduced bond purchases could help the yen appreciate by raising Japanese government bond yields, narrowing the interest rate differential between the United States and Japan, reducing investors' preference for dollar assets and increasing investment in yen assets instead.

From the historical trend of the yen exchange rate, it can be found that exchange rate changes are also affected by various factors such as economic fundamentals, interest rate differentials, and inflation. The strategy team of Ping An Bank believes that the exchange rate intervention measures are effective in the short term, but will not promote the reversal of the yen trend, but more to slow down the speed of yen depreciation, and the key to this round of yen trend lies in the monetary policy shift of the Bank of Japan and the US dollar. In the short term, the yen will remain weak. In the medium to long term, the marginal effect of the current round of rapid depreciation of the yen on attracting foreign capital inflows is weakening, and the volatility of foreign capital flows has increased recently, and the Japanese authorities may consider lowering the upper limit of the depreciation of the yen.

Alvin Tan, head of Asian FX strategy at RBC Capital Markets in Singapore, believes that in the face of a "huge" US-Japan interest rate differential, if US interest rates do not fall, the impact of the intervention of the Japanese authorities will quickly dissipate and the USD/JPY exchange rate will return to the level of 160.

Restoring confidence requires clear guidance

In March 2024, the Bank of Japan ended its eight-year negative interest rate policy, setting its policy rate in a range of 0% to 0.1% while removing the yield curve control (YCC) policy.

However, the Bank of Japan still said at the time that it would continue to buy Japanese government bonds for about the same amount as before.

On 26 April, the Bank of Japan (BOJ) decided to keep the current monetary policy unchanged at its monetary policy meeting. However, given the risk of rising prices in the context of a weaker yen, there is already an argument in favour of further rate hikes, that is, "if the rate of underlying price inflation continues to exceed expectations against the backdrop of a weaker yen, it is entirely possible that the pace of normalization will accelerate."

On May 8, Bank of Japan Governor Kazuo Ueda said that foreign exchange fluctuations are one of the important factors affecting the economy and prices, and that a rapid and unilateral decline in the yen is not good for the Japanese economy and is undesirable, and it is necessary to pay attention to the risk that the impact of exchange rate fluctuations on inflation is becoming greater than in the past. The central bank is likely to respond with monetary policy.

Kazuo Ueda also said that the impact of the yen's depreciation on inflation is increasing as Japanese companies tend to pass on higher costs to consumers by raising prices.

After his speech, the market renewed expectations that the Bank of Japan may raise interest rates in June.

Yang Aozheng believes that although Kazuo Ueda has changed his rhetoric, the yen has basically not attracted the attention of the market after his statement on May 8. It can be seen that the Bank of Japan's intervention in the foreign exchange market after its March decision and the interest in the yen's fluctuations have not had an impact on the depreciation of the yen, and even the market is questioning whether it will take measures to deal with it. The market has paid less attention to and trusted the BOJ's "talk but not do" behavior, and the BOJ needs clearer and clearer guidance on its position before the June interest rate decision, which is expected to restore the market's confidence in the BOJ's rhetoric. As the Fed continues to delay interest rate cuts, if the Bank of Japan continues to fail to provide clear guidance on its interest rate stance, the depreciation of the yen will still be the general direction.

Reporter Li Xizi