Speculation is rife over whether the Japanese government will use its vast foreign exchange reserves to protect the value of the yen. We hope she will make a limited intervention, but not for long. Japan should expect a much weaker yen in the near future as the country’s economic situation continues to deteriorate. However, as long as the Bank of Japan (BoJ) sticks to its current monetary policy, there is no point in protecting the currency.

A market commentary by Hendrik Tuch, Head of Fixed Income NL at Aegon Asset Management

At first glance, Japan does not appear to be a prime candidate for currency weakness as the combined corporate and personal savings rate is still 25% and inflation is below 3%. But these figures are likely to worsen as Japanese consumers are forced to spend more and inflation is expected to rise due to the weak yen. Japan’s public deficit is expected to improve somewhat after the lifting of COVID-19 measures, but it needs to remain high to stimulate sluggish economic growth.

BoJ monetary policy: main contributor to yen weakness

As long as the Japanese central bank sticks to its policy of no more than 25 basis points on 10-year Japanese government bonds, trying to strengthen the yen is futile. Unless current monetary policy changes, Japan faces a cycle of low currency, high inflation, and then further currency weakness. Although Japan’s monetary and financial authorities may have influenced financial markets, they are unlikely to intervene in any way to protect the value of the yen this time around, preferring instead to rely on policy changes. monetary.

The BoJ is certainly no stranger to financial market influence, as it already owns 43% of all Japanese government bonds and around 7% of Japanese equities. Additionally, Japan has huge currency reserves of $1.2 trillion. This is a good starting point for what could be a long monetary intervention. The yen saw a temporary rise after the Bank of Japan, the Ministry of Finance and the Financial Services Agency issued a joint statement expressing concern over the pace of the yen’s depreciation and “will act accordingly if necessary”.

The impact of this statement was limited to a few hours, however, as US CPI figures dragged equity markets lower and strengthened the dollar, leaving Japanese financial authorities to act if they wanted to reverse the current trend. Eh.

The Japanese authorities will probably first try to control the weakness of the yen through interventions, but then decide that it is better to adjust the BoJ’s monetary policy. As in previous cycles, the BoJ will be the last of the major central banks to begin the cycle of rate hikes, and at that time the global economic cycle should peak.

The yen down nearly 30%

As investors benefited from higher-yielding carry strategies against the yen, a change in BoJ monetary policy would put an end to this. Since the start of this year, the yen has lost about 17% of its value against the dollar and more than 10% on a trade-weighted basis. Adding to the deficit in 2021, the yen falls by around 30% in 18 months, the financial markets should further depreciate the currency.

Even though the U.S. two-year interest rate is at its all-time high, the yield spread over short-term Japanese government bonds is still above 3% at around 2.8%, the all-time high. since 2007.

Investors looking for a carry strategy now have a wide range of high-yielding government bonds relative to the Japanese bond market. With stock markets down around 15% year-on-year, a longer-term strategy for the Brazilian real would be to appreciate more than 35% against the yen.

The next change in the BoJ’s monetary policy stance will coincide with the peak of the business cycle. They will end the “carry strategy” and join a tight global monetary policy that is putting pressure on financial markets.

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