FinClient

I should start by saying this is an information dump from our team over the last 18- months from trading the Yen. The USD/JPY exchange rate now stands at 147.70, (30.01/24,) just under the recent ~ 150 high.

With USD/JPY approaching the 150 level, its cheapest since multi-decade lows set In October 2022, its time for another revision. I believe BoJ can no longer ignore the risk of excessive currency weakness upsetting price stability. I’ve been a buyer since 110 myself. The buying of JGBs is still heavy, but will they decide to abandon the 10YR JGB yield target? The easing is not done yet; NIRP and bond purchases are here to stay for now. Given the last meeting tone, I was surprised to hear so many positive comments on wage and price trends. Like “Japan is gradually transitioning to a world in which overall inflation expectations are rising in a sense and price norms are changing.” Whether corps have the funds to raise wages in 2024 is yet to be seen. A bigger inflationary environment could certainly do well for Japan given how much of a beating the currency has taken. You should be positioning for this now, retail! The risk of further decline in the JPY may also encourage the BoJ to move ahead with policy revisions. Remember the bank cited volatility in FX rates and other markets as one reason why it adopted a more flexible approach to YCC at the July meeting? Although nominal interest rate differentials are not the only factor determining FX rates, the size of the spread between US and Japanese interest rates has almost certainly reassured dollar buyers and yen sellers. The cheap yen is a positive for exporter earnings but also has increased outflows of domestic income via the rising cost of imports. Price stability is the central goal of monetary policy, and it can be upset by excessive fluctuations in exchange rates.

So looking ahead at short-term policy rates and the BoJ’s tiered current accounts structure after NIRP is wound down. Making bets on what happens next is where the money will be made. The current policy rate, as we all know, is the -0.1% rate paid on policy rate balances in current accounts at the central bank. When NIRP is finished, TONA, which is the weighted average of uncollateralized overnight call rates, will step up to become the new short-term interest rate target. Many think TONA will represent the risk-free rate since the discontinuation of LIBOR; this means the BoJ will likely seek to use it as a conduit for monetary policy. It remains to be seen what the initial guide range for TONA will be. But to make this viable, the BoJ will have to adjust its reserve structure. The BoJ has a three-tier structure; most interestingly, CB’s that have tiered structures under negative rates have only two tiers; a 0% tier and a negative tier. But the BoJ has 1) basic balances earning +0.1%, 2) macro balances earning 0%, and 3) policy rate balances also earning 0.1%. Perhaps the reason for the tree-tiered structure is due to the BoJ’s massive bond purchase that had already produced a large pool of excess reserves that were earning a rate of 0.1% prior to NIRP. The corporate earnings would have taken a major hit if that rate had been made zero or negative like a two-tier structure. Since an end to NIRP would reduce the need for three-tiers, make sure to be watching carefully. I build my whole trading case study on this.

With currencies, it is always dangerous to try to anticipate a change of direction, even when the fundamentals cry out for it, and our performance has suffered accordingly. We believe the yen is oversold for technical reasons and that, when these dissipate, it is likely to move sharply higher. Moreover, when it does, it is likely to be concentrated into a brisk, uncontrollable move upwards.

The Japanese yen recently drifted past 150 against the US dollar again before
probably triggering a likely Bank of Japan intervention. If it smashes past that mark again, it will be at its weakest level versus the dollar since the Japanese bubble burst in the early 1990’s. In fact, the yen is not only comfortably the world’s worst performing major currency in 2023; it is the worst performer of ANY currency tracked by Bloomberg. After several attempts to cautiously fiddle around with its “yield curve control” policy, the Bank of Japan will soon have to scrap it altogether. The current betting is that this is likely to happen next year, perhaps after the annual “Shunto” wage negotiations in March 2024, where Japan’s biggest labour union is now seeking ”at least” a 5 percent pay increase. The subsequent death of YCC will send Japanese government bond yields spiralling higher re removing the last anchor for global fixed income markets — and an restore the yen’s win.

Moreover, plenty of investors reckon that the unexpected global economic
resilience to tighter monetary policy will finally end next year. That will throw
interest rates into reverse, narrow the spread of other government bond market yields over Japan — whatever happens with YCC. On top of that, the yen is a classic ‘safe haven’ currency that tends to strengthen when markets are in a tailspin. And there’s plenty of fuel for a rally, given that the inflation-adjusted valuation gap between the US dollar and the Japanese yen is the most extreme in global currency markets, according to JP Morgan. The looming question? If there is a global recession looming, why would the BoJ tighten monetary policy by scrapping YCC going into it? As we still haven’t seen much of a safe-haven bid for the yen yet.

You can eventually expect the local demand for the yen to come around in the
aftermath of BOJ Governor Ueda’s increasing isolation in attempting to hold the yields of government bonds well below international rates. The best way to get out of this “death spiral” is for the government to compel domestic corporations to acquire the bonds at their currency expense prices. For Japanese corporations to be able to do this, many will have to sell down big holdings of foreign government bonds, denominated in foreign currencies. I’m looking at you, USD. Remember, a lot of the holdings have already been hedged into yen, but much will be held in jpy. Naturally, those forced sellers are foreigners who have borrowed in yen to enjoy a lower interest rate regime, that the one in which the assets are purchased.

Now if we look at JPY swap rates, that have risen from Q4 23, especially on the
long-end, mainly from the ripple effects of the BoJ surprise decision to expand the range for the target 10YR JGB yield, those paying attention would have noticed the downward pressure that followed as BoJ stayed the course.