BOJ last week: Calm at heart amid turbulent markets

Following the BOJ meeting and even the week before, the Japanese Yen has nearly collapsed to its lowest level in 38 years. 

• USD/JPY exchange rate has surpassed 158 – far exceeding the levels that prompted BOJ interventions in the past.

  

Although Japanese Finance Minister Shunichi Suzuki affirmed after the BOJ meeting (last Thursday) that: BOJ will take appropriate action based on forex market movements (forex)… BOJ actually made no statements about protecting the Yen. 

A series of questions have been raised for investors and forex traders:

1. What are the causes of the Yen's depreciation?

2. What is BOJ's current stance and policy objectives?

3. What impact does the Yen's depreciation have on financial markets and the US economy (as well as globally)?

This week, continuing to follow global economic events, Viet Hustler's Macro Economics article will analyze these aspects for readers.

Disclaimer: Some views below are the personal opinions of the author group, and not investment advice!

1- Why did JPY depreciate so quickly last week?

Simply due to investors' fears on the Forex market about the interest rate policy and stance differences between the two central banks.

On interest rate policy

• The base interest rate (Fed rate) in the US remains very high: 5.25% - 5.5%

• While short-term rates in Japan (BOJ) remain at 0% - 0.1%.

  • While interest rates are essentially the "value" of the currency – this means USD value remains much higher than JPY.

However, for the market to react so strongly, it's mainly the stance of the two central banks.

• In the face of persistent US inflation data and tight labor market in recent weeks in the US – the Fed is expected to remain hawkish and keep rates high for longer.

  

• Meanwhile, at last week's BOJ meeting, BOJ kept short-term interest rate policy unchanged at 0% - 0.1% + kept QE pace unchanged from the previous month.

  • Previously, with Rengo's victory in wage negotiations, investors expected BOJ to be more hawkish than last week's stance.

  

• The difference in stance between the two central banks makes investors fear USD will strengthen further against JPY in the future:

  • The wave of JPY selling intensified last week:

    

• FYI: The next important event that could impact the Yen is the May FOMC meeting next week (05/01)!

2- What is the basis for BOJ maintaining a "rather dovish" stance?

Looking at BOJ's economic outlook forecasts after last week's meeting, BOJ's "dovish" stance is fully justified:

• BOJ predicts Japan's economy will grow more slowly…

• While inflation is not yet "sustainably high" for an economy that has just gone through a decade of deflation.

In the economic outlook report, BOJ mostly comments that the economy is recovering at a moderate level …

• with most things only at moderate levels (moderate / moderately repeated many times)

  

• Including many unpromising signs such as:

  • Industrial production trending flat and declining recently.

  • Exports also flat

  • Housing investment weak - public investment also flat

• The bright spots in Japan's economy are only in household income and fixed business investment increasing (but still only moderate).

• Nevertheless, corporate profits and business sentiment have improved.

Opinion: Actually, BOJ may not need to worry too much; it will take time for the impact of wage growth to clearly reflect in increased consumer demand.

• Currently, Japan's PMI indices are showing clear signs of improvement, indicating that manufacturers expect demand for goods to increase.

  

• In addition, the Golden Week in Japan has currently begun (lasting from 04/22 - 05/06), this is an opportunity to test the spending power of Japanese people as wages have gradually increased.

From a policy planning perspective, the dovish stance of the BOJ is completely appropriate when:

1. Inflation is not concerning enough for the BOJ to hastily raise interest rates to curb inflation.

   • The BOJ even wants to maintain inflation around 2 - 3% as it is now.

2. In addition, raising interest rates could cause Japan's economy, already under high interest rate pressure and sluggish growth, to weaken even further.

3- Why hasn't the BOJ intervened in the market to protect the JPY as in previous times?

One of the reasons for the strong reaction in the forex market after the BOJ meeting is that:

BOJ has no statements or actions to protect the Yen like in previous Yen depreciation episodes.

However, it must be said that from Japan's domestic economic perspective, the current Yen depreciation may not be a bad thing:

• Reason 1: What the BOJ needs is to maintain inflation at the current level — and a cheaper Yen will make imported goods into Japan more expensive!

  • This is exactly the source of inflation that the BOJ desires — because Japanese people use a lot of imported goods.

    • It is no coincidence that the value of imports into Japan peaked right at the time of October 2022 when the Yen plummeted and inflation was on the rise.

      

  • FYI: In the previous BOJ intervention in October 2022, Japan's inflation was +3.7% y/y at that time — which created pressure for the BOJ to protect the JPY to stabilize import prices.

    • But currently, Japan's inflation is only +2.7% y/y — the BOJ will want to keep import prices high to maintain this inflation level!

      

• Reason 2: A low JPY will attract more tourists to Japan, accompanied by increased exports for manufacturing businesses in Japan

  => Both aspects can create growth for Japan's economy, which is still quite “moderate” (average - as described by the BOJ).

From the perspective of international economic relations:

The BOJ protecting the Japanese Yen by directly buying large amounts of JPY with USD could affect the USD and the Fed in the current crisis context.

Therefore:

1- The BOJ will need to consult other central banks in the G7 group on this issue, or

2- The BOJ will not be able to buy large amounts of JPY like in October 2022, but will need to split it up and buy gradually, to avoid too much impact on the forex market: causing a strong squeeze in the USD value (rising too high then dropping suddenly).

4- The dilemma facing Yen Carry Trade traders in the current financial markets

First, it must be affirmed that the Yen Carry Trade market is quite large — even though there are no official statistics for the value of these activities.

• A Reuter article from 2007 stated that the value of Yen Carry Trade transactions had reached USD 150 billion (calculated in USD value at that time).

  • Note that at that time, the BOJ had not yet lowered short-term interest rates to negative levels (in 2016) or implemented aggressive QE (from 2013).

  • Therefore, at the present time, the Yen Carry Trade market value will be much larger than that figure!

  

• Therefore, the difficulties of Yen Carry Trade traders will have some impact (though not too much) on the global financial market.

The issue of the Yen value and Yen Carry Trade transactions:

The nature of Yen Carry Trade transactions:

Investors borrow JPY (currently still at low interest rates) to invest in foreign assets in foreign currency (e.g., US T-bond listed in USD).

Of course, besides hedging the risk of the value of USD investments, they also have to hedge the exchange rate risk of the Yen (JPY).

• Investors can hedge part of the exchange rate risk through swap transactions in the Forex market (FX Swap).

  • FX Swap is similar to Currency Swap transactions - Currency Swap which Viet Hustler mentioned in a previous article.

  • However, FX Swap transactions require participants to post margin:

    For example: an investor performing a swap of JPY for USD must post margin in an amount of JPY corresponding to the current USD exchange rate.

  • When the value of JPY falls too low, the party posting JPY margin will have to send additional JPY to balance the amount of USD they have taken (similar to margin call for leveraged transactions).

    • Of course, when the value of JPY rises, the investor benefits, and the broker must add more collateral/USD to that swap transaction.

    • But what Viet Hustler wants to emphasize here is the case where JPY is depreciating as it is currently.

People might say:

If the JPY depreciates, investing more from JPY into foreign assets (USD) would be disadvantageous, but converting back from USD to JPY would be profitable

—> Investors can retrieve JPY at this time to spend in Japan or wait for JPY to appreciate again.

=> In theory, that's how it is… but the current situation is not like that.

When the JPY depreciates as described above, investors can still choose:

1. post additional JPY margin, or

2. cancel the swap transaction. 

But in the current situation, they will choose option 1 because

Their USD-denominated investments (or other foreign currencies) are not easily liquidated to obtain enough USD to settle and close the FX Swap contract.

• Because high interest rates in Western markets are causing the USD bonds (or EUR, GBP…) they bought earlier to lose value.

• If they sell these USD fixed income assets now (e.g., T-bond or T-Notes), they will have to incur larger bond losses.

• Therefore, they will choose to post additional JPY into the current FX Swap position.

The question arises:

If investors use Yen Carry Trade transactions, where do they get the JPY from when they need to post additional margin?

(Especially if they are not Japanese or do not have income in JPY). 

• Of course, they will have to sell short-term / high-liquidity investment assets (those not losing much value due to FX risk) in Western markets – for example, overnight reverse repo contracts (Overnight RRP).

So why don't brokers use the additional JPY margin newly posted by investors to invest? 

• Most of them will not do so — because currently JPY investments are quite inefficient (compared to USD) and most brokers will not engage in market-directional activities.

Therefore, it can be said that the additional posted JPY is 'dead money', contributing to draining liquidity from the market…

5- What impact does the Yen Carry Trade market have on the US financial market?

The main answer is:

Last week, as the JPY weakened, Yen Carry traders came up with a new plan:

• Borrow in Yen (which is weak) at good rates... and invest in Gold (instead of US Treasury bonds) using the JPY itself.

  • The volume of spot Gold transactions in Yen has increased significantly in the past 2 months.

    

  • High demand for gold reserves from Central Banks is keeping gold at a stable value level (at least enough for investors to wait for the Yen to appreciate again). 

  • And of course, they don't have to worry about exchange rate risk….

• And as Viet Hustler has reported for nearly 3 weeks: Demand for medium- and long-term US Treasury bonds is gradually weakening!

  

CONCLUSION

The impact of policy divergence between the two major Central Banks on the forex market can be clearly seen: When the Fed is more hawkish - BOJ more dovish… the JPY depreciates more against the USD!

However, each Central Bank has its own economic policy objectives, so the turmoil in the forex market is just the 'price' these institutions have to pay to achieve their goals.

• On the BOJ side, with inflation at the level BOJ desires, this bank has no pressure to raise interest rates, stop QE…. or protect the JPY immediately.

• Because the weakening JPY has a positive impact on import price growth (to maintain high inflation in Japan), tourism and export growth (boosting economic growth + nominal wage growth).

However, the forex and financial markets are in turmoil when BOJ does not protect the JPY — simply because Yen Carry Trade positions in the global financial market are quite large. The JPY depreciation will force these traders to post additional JPY to balance USD-JPY Swap positions. They also do not want to sell USD-denominated listed bonds — simply because they do not want to recognize bond losses at a time when yields are rising sharply.

On the US side, the JPY decline against the USD is making the already weak demand for US Treasury bonds even weaker. If JPY continues to depreciate further, BOJ may still have to buy JPY with USD. The Fed may also need to coordinate with BOJ to avoid BOJ buying too much JPY— creating a strong squeeze on the USD.