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Market summary: Another bad quarter
The Japanese yen has fallen sharply in the first three months of 2024, depreciating significantly against the US dollar, euro, and British pound, with much of this weakness due to differences in monetary policy. While major central banks such as the Federal Reserve, ECB, and BOE have kept interest rates at multi-decade highs in an effort to beat inflation and restore price stability, the Bank of Japan has largely maintained an ultra-accommodative stance; This widened the yield gap. Japanese currency.
The chart below shows the year-to-date (as of March 21st) performance of USD/JPY, EUR/JPY, and GBP/JPY. In addition, the yield gap between 10-year government bonds in the United States, the euro area, and the United Kingdom and equivalent government bonds in Japan is widening, and this has been shown to be a bearish factor for the yen exchange rate.
Japanese yen performance and yield differential in the first quarter
Source: TradingView, created by Diego Colman
Bank of Japan abandons negative interest rates due to earthquake fluctuations
A big change occurred towards the end of the first quarter. In a historic move, the Bank of Japan raised borrowing costs from -0.10% to 0.00%-0.10% at its March meeting, the first increase in 17 years. This marks the end of the bank’s years-long experiment with negative interest rates, aimed at stimulating the economy and breaking the deflationary “mindset” of Japanese people. At the meeting, financial institutions led by Kazuo Ueda also announced that they would end the yield curve control system and stop buying ETFs.
The decision to begin easing economic stimulus measures comes as a result of salary negotiations between Japan’s largest federation of labor unions and major companies, resulting in a significant increase in worker pay of more than 5.2%, the highest in more than 30 years. The decision was made in response to the Policymakers believed strong wage growth would foster sustained economic growth and create a virtuous cycle of sustainable 2.0% inflation supported by strong domestic demand.
Despite the Bank of Japan’s policy change, the yen continued to fall and, paradoxically, showed little sign of recovery in the days that followed. The reason for this was that the market perceived the central bank’s hike as a “very dovish rate hike” and expected financial conditions to remain extremely accommodative for a long time, meaning that the normalization cycle would be very slow. . According to their logic, this will maintain Japan’s yield disadvantage relative to other countries for the time being.
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Clearer skies await
The second quarter may herald a bullish shift for the yen, but it may not happen soon. One potential factor could be the Bank of Japan’s monetary tightening campaign. The Bank of Japan signaled neutrality and gave no clear guidance on when it would raise rates again after the end of its March meeting, but the next round will come as the Federal Reserve, ECB and BoE begin to adjust. The adjustment could take place in July or, more likely, in October. Back to policy restraint.
With the yen languishing at multi-year lows and global oil prices rising, Japan’s headline inflation rate accelerated to 2.8% year-on-year in February, exceeding the Bank of Japan’s target for the 23rd consecutive month. However, there is a possibility that the trend will continue to trend upward. This situation, combined with government officials’ dissatisfaction with the extremely weak currency and a desire to reverse the trend, raises the possibility that the Bank of Japan will make another move sooner rather than later. Traders may be underestimating this risk.
Many Japanese companies are reportedly bringing forward capital investment and rushing to secure bank loans before loan costs rise again. All things being equal, this is a positive development that could support economic activity and boost demand-pull inflation in the coming months, giving policymakers more confidence in the prospects for further rate hikes. You will be able to have
Funds repatriation in progress
In recent years, Japanese investors have had no choice but to deploy capital monitoring and deploy more than $4 trillion in capital in search of higher yields in response to the Bank of Japan’s hyper-dovish stance and unconventional monetary policy. Despite the high currency hedging costs associated with this strategy, it has been the go-to option for domestic investors seeking more attractive investment opportunities in high-quality foreign assets.
With the Bank of Japan finally easing its economic stimulus and other central banks moving in the opposite direction, Japanese investors will soon start liquidating their positions in overseas assets and repatriating their funds in an orderly process. This could lead to an increase in demand for the yen. Of course, this won’t happen overnight, but a multitrillion-dollar reversal in capital flows should eventually provide a tailwind for the yen and pave the way for a more sustained rebound.
basic outlook
Looking ahead to the second quarter, the yen appears to be well-positioned for stability and a potential turnaround. This optimism is not just the result of the Bank of Japan’s exit from negative interest rates. An impending easing cycle by the Federal Reserve, European Central Bank and Bank of England is poised to bring further strengthening. With this in mind, USD/JPY, EUR/JPY, and GBP/JPY are likely to decline gradually over the coming months.
