Hey…has anyone else noticed that Japan’s safe-haven currency is starting to get nervous?
The idle car crash that is the Japanese yen continues. He’s headed for the bridge and currency analysts fear there’s no stopping him this time and that’s impacting all of us because there’s a basket of currencies in the back seat.
Traditionally, the yen has oscillated at its own pace. It has often been a bit of a safe-haven currency – a good place to land when your capital flight is weighed down by risky assets. Similarly, when the yen is under pressure, it is a surefire indicator of growing demand for risky assets.
But this explanation hardly matches what is happening now, according to Alex Kuptsikevich, senior market analyst at FxPro.
He says it might be time for the markets to make a “significant reassessment” of Japan’s position in the financial system.
“In the worst case, this could turn into a debt crisis in the land of the rising sun,” he said.
But he will not stay in the archipelago, warns Kuptsikevich.
“This could be an even bigger disaster for financial markets than the eurozone debt crisis of a decade ago.”
The re-weakening of the yen began in February
It was a peaceful time, a sacred time.
A time when in-demand stocks were free and still an attractive area for capital to flow and increase the purchasing power of investments.
This tap was suddenly turned off when Russian tanks entered Ukraine, but it has accelerated over the past two weeks on signs that these events have accelerated processes that were taking place before.
Even before the COVID-19 pandemic, Japan was an absolute laggard when it came to maintaining fiscal discipline.
But a concerted effort in the five years before COVID-19 to reduce the budget deficit led to public debt stabilizing at around 235% of GDP. Agreed. That’s still twice as much as the Americans and about six times as much as Australia’s last reading.
“These processes are now more visible in the dynamics of the Japanese yen against currencies where the central bank can respond adequately to inflation,” notes Alex Kuptsikevich.
Since early February, USDJPY has risen 6.5%, and almost all of that rise has taken place since March 7, bringing the pair back to levels last seen in late 2015.
A much more impressive rally is underway for the Aussie and the Kiwi against the Yen. Since the beginning of February, they have jumped by more than 12%.
So far this month, the strengthening is the biggest in 11 years for the AUDJPY and in more than 12 years for the NZDJPY.
“The interest rate differential game,” says Kuptsikevich, “which was so popular with traders in Japan before the global financial crisis, has found a second life.”
Because countries like Australia and New Zealand, with entirely different economic structure and monetary policy settings, have the economic potential to raise interest rates.
Like us, even the Kiwis are benefiting from a material filling of the boxes, while export prices are exploding.
The Fed continues to warn that it will have to deploy the big guns in its battle against inflation. Traders expected faster rate hikes to reflect this change, but the USD didn’t really come out on top as expected.
Instead, it was the yen that suffered.
The Fed leads the chasing pack
Fed chairs keep hammering it home – “whatever it takes” – they say, to calm inflation, nothing is on the table.
This means raising interest rates as quickly as possible to slow the US economy and it is a relevant message that has been carried through global markets.
Treasury yields have soared, said Peter McGuire, CEO of XM.
“They eclipsed pre-pandemic levels as traders rushed to fix prices in a faster squeeze.
With US yields on the rise, one would have expected the dollar to make its way into the forex arena. Further rate increases of another seven and a half points are now scheduled for this year, which would push the federal funds rate to around 2.25% by December.
But that was not the case.
“Instead of the dollar strengthening, it was the yen that was demolished,” McGuire said.
“When the Fed brakes, everyone should follow suit. Even in Europe, traders have recently increased their bets on rate hikes, propelling European yields higher. While the ECB will be slower than the Fed, this revision was enough to negate the impact on the euro/dollar.
But the yen is the exception to this rule.
The bank harassed by Japan (BoJ) is the only major central bank not expected to raise rates this year. It also remains committed to its yield curve control strategy, which prevents Japanese yields to rise beyond a certain level and therefore makes the yen less attractive when foreign yields soar.
While supporting the economy remains a priority over fighting inflation, BoJ policymakers were paying more attention to rising inflationary pressures even before Russia’s invasion of Ukraine. a month ago today.
But wait, there’s worse
Kuptsikevich says the situation in Japan is more alarming than the status quo.
“While Japan’s debt-to-GDP ratio has increased by 77 percentage points to 170% since the financial crisis. The Bank of Japan’s ongoing QE has reduced public debt costs, but does not solve the problem,” he said.
Japan was overthrown
Over the past decade, Japan has become a net importer of commodities due to its growing dependence on energy and metals and growing competition from China and Korea.
Soaring commodity prices – fuel and grain to start – are putting enormous pressure on the resource-poor island state by raising import costs, widening the trade deficit and putting a huge question mark on the BoJ’s hope that it will be able to bring the world’s third-largest economy on a nice and moderate recovery.
Kuptsikevich doesn’t see this going as planned. He says that in this situation, generally, the exchange rate should act as a natural mechanism to stabilize trade.
“But this adjustment is difficult for indebted Japan because selling currency would de facto mean selling bonds denominated in that currency,” he said.
Under these circumstances, the Bank of Japan will either have to openly agree to finance the government (i.e. increase purchases despite inflation) or ease QE (i.e. cancel the stimulus).
“The first option risks triggering a historic revaluation of the yen,” warns Kuptsikevich. “The second option would deal a blow to the economy and finances by raising questions about Japan’s ability to service its debt.”
At last week’s meeting, the central bank downgraded its economic outlook, and with risks still unexplored a month after the start of the Ukraine crisis, the bank made it clear that it was in no rush to recall the raise.
Because there is no other option.