The yen experienced a notable increase on Monday, buoyed by remarks from Bank of Japan (BOJ) Governor Kazuo Ueda hinting at a potential near-term interest rate hike. However, Japanese Finance Minister Satsuki Katayama finds herself in a challenging situation regarding the currency’s stability. Despite the deployment of over 11.7 trillion yen (approximately $72.8 billion) in foreign reserves to support the yen from late April to May and the BOJ’s decision to raise policy rates to their highest level in more than three decades, the yen continues to hover around the 160 mark against the US dollar.
Masahiko Loo, a senior fixed income strategist at State Street Investment Management, described the recent rate hike as somewhat insufficient, characterizing it as a “Band-Aid on a bullet wound” for the struggling yen. In early June, officials, including Katayama, signaled Japan’s readiness to take “decisive action” in response to excessive volatility in the yen. However, this advance notice may have diminished the element of surprise that could enhance the effectiveness of any market intervention. Loo remarked that the clarity of these warnings implies that any preemptive actions may provide only ephemeral relief.
On April 30, the yen had a brief surge, appreciating sharply from 160.39 to 156.6 against the dollar, leading to speculation that Tokyo had intervened in the market. The currency strengthened further to around 155 the next day, but soon began to depreciate once again. Financial experts suggested that Japan likely intervened during the Golden Week holidays in early May when the yen was around 158, yet this maneuver did not prevent the currency from drifting back towards the 160 level.
The inability of the intervention and rate hike to stabilize the yen is attributed to various structural factors affecting the currency. While the BOJ tightens its policy, high U.S. bond yields continue to make the so-called carry trade appealing for investors. This type of trading involves borrowing in low-interest currencies like the yen and investing in higher-yield assets. Currently, 10-year Japanese Government Bonds yield around 2.64%, while their U.S. counterparts offer yields of 4.451%, creating a gap that sustains the carry trade.
Political factors also play a significant role. The administration of Prime Minister Sanae Takaichi maintains a reflationary stance, supporting an easy monetary policy aimed at boosting Japan’s economic growth. This political backdrop casts uncertainty over the policy outlook, potentially hindering foreign capital inflows into Japan. In February, two academics known for their dovish views were nominated to join the BOJ board, indicating a preference for expansionary fiscal and monetary strategies. Toichiro Asada, who dissented against the recent rate hike, is now on the board, and Ayano Sato is set to replace outgoing member Junko Nakagawa at the end of this month.
Japan’s dependence on imported energy, particularly in light of the ongoing conflict in Iran that has kept prices high, further complicates the currency situation. The nation’s need to purchase dollars for energy imports adds pressure to the yen. Hirofumi Suzuki, head of the research group at Sumitomo Mitsui Banking Corporation, noted that while FX intervention is aimed at reducing volatility and deterring speculative selling of the yen, authorities are currently focused on monitoring price fluctuations.
Short-term speculation indicates a high likelihood of intervention due to increasing short positions against the yen, which have risen beyond levels observed prior to the Golden Week interventions. The resolution of tensions in the Middle East, particularly if a deal between the U.S. and Iran leads to renewed shipments through the Hormuz Strait, could alleviate Japan’s energy import costs and reduce the downward pressure on its currency.
Looking ahead, Loo mentioned that longer-term capital flows might become more favorable for the yen, driven by rising interest in AI-related investments, growing foreign interest in Japanese equities, and a technology-led rally in the Nikkei.
