Takahide Kiuchi's View - Insight into World Economic Trends: The Battle Between the Market and the Authorities Over the 1USD/150JPY Exchange Rate
Oct. 13, 2023
The tendency towards a weaker yen and stronger dollar in the exchange market has been intensifying. On October 3, 2023, the yen depreciated even further against the dollar on the New York market, with the yen/dollar exchange rate briefly hitting the level of 1USD/150JPY. This was immediately followed by a drop which saw the yen trading back at the 1USD/147JPY level, making for quite a volatile day for the exchange market. Despite observations that the Japanese government might have made a currency intervention to buy yen and sell dollars, the government has not made clear whether any such intervention took place.
The yen’s ongoing depreciating trend from the start of the year has brought it to the 1USD/150JPY level
If we take a look at trends in the exchange market since last year, we see that from March 2022 onward, the substantial policy interest rate hikes enacted by the FRB (Federal Reserve Board) have been a leading factor in driving the yen to depreciate dramatically against the dollar, and the yen/dollar exchange rate went from around 1USD/115JPY in March to around 1USD/145JPY in September. The dollar rose relative to all major currencies, creating a stronger sense of the dollar as the only strong currency in a declining market.
When the yen/dollar exchange rate hit the level of 1USD/146JPY, the government embarked on a currency intervention on September 22, 2022, by buying yen and selling dollars. That was in fact its first yen-buying intervention in 24 years since June 1998. Subsequently, the yen’s depreciation against the dollar peaked at the level of 151.5-152.0 yen against the dollar on October 21, after which the yen began to appreciate versus the dollar.
Furthermore, speculation that the Bank of Japan would move to normalize monetary policy with a new Governor at the helm starting in April 2023 created upward pressure on the yen, and in January 2023 the yen was back trading at 1USD/127JPY. Yet even after the new Governor took office the Bank of Japan maintained its extraordinary monetary easing program, leading the yen once again to depreciate considerably against the dollar, and ever since July, there has been intense speculation that policy interest rates will remain high even after the FRB is done with its rate hikes, which in turn has led long-term government bond yields to rise. In the midst of all this, the dollar now stands once more as the lone strong currency compared to all other major currencies.
And then on October 3, we saw the yen/dollar exchange rate briefly hit the level of 1USD/150JPY, which was near the peak of the yen’s depreciation in 2022.
1USD/150JPY as the first defensive line?
On October 3, 2023 (Japan time), when the rate was just about to hit 1USD/150JPY, Finance Minister Shunichi Suzuki announced that “All measures are still on the table, with a heightened sense of urgency”, moving to curb the yen’s depreciation. When asked if the level of 1USD/150JPY would serve as a turning point for a currency intervention, he stated his view that “Currency levels themselves are not a factor in our judgment. It’s a matter of volatility”.
However, Finance Minister Suzuki’s remark that currency levels aren’t a factor in judging whether to carry out a currency intervention is likely only a pose meant to be seen by the U.S. government, rather than the actual truth. The U.S. government’s stance toward advanced nations is to oppose currency interventions that seek to bring exchange rates to specific levels or that aim to influence the direction of a currency, as it regards such interventions as currency manipulation. It tolerates only those currency interventions involving smoothing operations aimed to suppress volatility, whenever speculation leads exchange rates to fluctuate excessively.
However, with the rate nearing the level of 1USD/150JPY, the Japanese government has been hinting at a currency intervention, which is to say, it has successively made “lip service” interventions to clamp down on the yen’s depreciation, and thus it would seem clear that the government has the level of 1USD/150JPY very much in mind as a psychologically critical juncture. It is warning that if the rate exceeds that level the depreciation of the yen will only worsen.
In addition, while the government is currently pursuing economic policies based on measures to combat inflation, the rise in import prices resulting from the yen’s depreciation will ultimately impede the effects of those policies. For that reason, the government likely believes that it has to stop the yen from weakening any further no matter what.
We may infer that the government views 1USD/150JPY as its first defensive line, 1USD/152JPY (given that the yen’s depreciation peaked in 2022 at the high end of the 1USD/151JPY range) as its second defensive line, and 1USD/155JPY as its third defensive line.
Even though the government made no currency intervention in the New York market on October 3, it’s still possible that it will move to intervene in the Tokyo market before long, seizing the opportunity as the yen continues to depreciate.
The BOJ’s YCC softening measures have had some effect in stopping the yen’s depreciation
The Bank of Japan has admitted that the operational tweaks that it made in July 2023 to YCC (Yield Curve Control), its framework for controlling long-term interest rates, was in some sense intended to lower volatility in the currency market.
Whenever long-term U.S. Treasury yields rise, it leads upward pressure to mount on long-term JGB yields in Japan. At such times, the Bank of Japan moves to clamp down on the rise in long-term JGB yields under this YCC framework, and this leads the gap in long-term yields between the U.S. and Japan to grow and makes it more likely for the yen to depreciate against the dollar.
The Bank of Japan made tweaks to YCC in July, starting to permit long-term JGB yields to increase beyond +0.5% (the upper limit of its variability range), and this led to higher volatility in long-term JGB yields. It will also lead to a proportional decline in currency market volatility. Although the yen did continue to weaken after the tweak to YCC was made, these softening measures would seem to have had some effect in halting the depreciation of the yen.
Moreover, when long-term interest rates were rising, the Bank of Japan permitted long-term JGB yields to increase to some degree, through measures such as putting off any extraordinary JGB purchasing operations, funds-supplying operations against pooled collateral, and fixed-rate purchase operations, and this also made it possible to stem the further depreciation of the yen. This is significantly different than what happened last year when the yen weakened, and it arguably means that the collaboration between the government and the Bank of Japan has deepened in the interest of halting the yen’s depreciation.
Rising long-term real interest rates have left only the dollar standing strong
When the dollar alone stood strong back in 2022, it was the result of the drastic rate hikes made by the FRB, accompanied by a substantial rise in long-term Treasury yields. Interest rates in the U.S. still remain on an upward track, but it has already become the prevalent view that these rate hikes are soon to be at an end.
Even if this rate hike phase is nearly finished, the FRB is not so apt to embark on full-scale easing, and with growing prospects that policy interest rates will remain high for the long haul, long-term Treasury yields have only risen further, causing the gap in long-term yields between Japan and the U.S. to widen and the dollar to appreciate. And yet as rate hikes increasingly seem to be in their final phase, it is surprising that the appreciation of the dollar has gone on this long.
I believe an underlying reason for this may be the rise in real yields (nominal yields – expected inflation rate) which have a major effect on exchange rates. As the inflation rate continues to steadily decline, short-term inflation expectations have been dropping. That would seem to be why real short-term yields have continued to climb.
The 10-year expected inflation rate—which is factored into inflation-linked bonds—has remained stable in the range of around 2.2% to 2.3%. The fact that 10-year Treasury yields have risen by as much as one percentage point since July signifies that real long-term yields have risen to nearly the same extent.
What we should bear in mind is that while a rise in real yields does lead to the dollar’s appreciation, it also demonstrably restrains economic activity and creates a headwind for the U.S. economy. If this results in a more severe slowdown in the U.S. economy, then long-term Treasury yields may fall, and any added fears that the strong dollar could adversely affect corporate competitiveness might also lead stock prices to drop.
In such a situation, the dollar could very well swing from this drastic appreciation all the way toward a massive depreciation. It would seem that we may now be nearing that kind of major inflection point in the dollar’s fluctuations.
The currency market in 2024: the dollar is set to weaken against the yen
Halting the yen’s ongoing depreciation will be difficult to achieve with currency interventions along (NRI Journal, “Can Foreign Exchange Intervention Halt the Yen’s Depreciation?”, Oct. 14, 2022 ). Currency interventions in the end are merely a stalling tactic, a way to buy time.
Over three days between the end of September and early October 2022, a total of 9.2 trillion yen in yen-buying, dollar-selling interventions were implemented. Meanwhile, according to research done by the BIS (Bank for International Settlements), as of April 2022 the average daily trading volume in Japan’s Forex market came out to $432.5 billion. When calculated at the current yen/dollar exchange rate, this works out to around 64.4 trillion yen. By contrast, the scale of the yen purchases over those three days totaling 9.2 trillion yen is rather small, and it would seem that it failed to have much impact on currency supply and demand. Barring any changes in the economic and monetary conditions in the U.S., such as any clear signs of an economic slowdown, it seems unlikely that the yen’s depreciation trend will reverse course.
Nevertheless, as we have already seen, the YCC tweaks in July have surely lowered the risk of further depreciation of the yen compared to before. Additionally, given what happened in 2022, when the yen depreciated by around five yen after the government made its currency intervention and then that depreciation peaked, we should consider the possibility that the third defensive line of 1USD/155JPY—a depreciation of around five yen from the first defensive line—is where the yen’s depreciation may peak.
Assuming that real yields rise further and/or the dollar’s appreciation creates headwinds, leading to a more pronounced slowdown of the U.S. economy, and prompting the FRB to enact monetary easing on a scale larger than expected, I foresee that the currency market in 2024 will flip and send the dollar on a downward trend.