Why is the yen so weak?

>> Will the BoJ use a three-step process to intervene in the FX market?

As usual, the operation received a good deal of scorn in the market on the basis that the yen is weak because US rates are high, and, until this changes, the BoJ is throwing money away. But again, as usual, the story seems a lot more complicated than this.

For a start, yen weakness is not some kind of new phenomenon that started when the Fed began to raise rates in 2022, while the BoJ stood idly by. For instance, the yen has halved against the US dollar since 2012, and yet, for the bulk of this period, the Fed has held the fed funds target at zero; barely above the BoJ’s policy rate.

Another point is that US rates have risen sharply in recent years compared to Switzerland and yet the franc has not undergone anything like the same fall as the yen. Yet another point, on a related theme, is that the yen’s fall in real effective terms suggests that the Japanese currency has not just seen problematic weakness in recent years.

Instead, the slide dates right back to 1995 which, perhaps ironically, came at a time when the BoJ was working hard, via intervention, to weaken an excessively strong yen. The fall in the real effective exchange rate also shows that the yen’s weakness has not just been against the higher-yielding dollar. For example, it has lost nearly two thirds of its value against the low-yielding Swiss franc since 2000. Hence, it seems that if we really want to understand the weakness of the yen and decide whether intervention might be effective, we probably need to get away from the rather simplistic assumption that it is all a function of high US rates.

But what other factors might explain the yen’s slide? The early-mid 1990s saw the explosion of the country’s stock market and housing bubble; ushering in a period of what’s been termed a balance sheet recession. This ‘recession’ reflects the fact that the value of household and corporate assets has been destroyed so much by the bursting of the bubble that policymakers could not effectively use monetary policy to entice consumers and firms to spend and invest more.

Any income gain they received from a lowering of policy rates was put aside to either pay down debt, or build a nest-egg in case another bubble burst in the future. The haplessness of the monetary authorities in this situation led to initiatives such as aggressive fiscal easing, resulting in huge public debt, quantitative easing – and a bias for yen weakness.

>> Is BoJ ready for currency intervention?

Now clearly, these biases seem to have changed, or at least some of them. Rates have started to rise, BoJ asset purchases are likely to slow, and, as we can see, the preference for yen weakness has long gone. But old habits die hard, and just as it took Japanese policymakers many years to turn the yen down (in 1995), it could take years to turn it back up again.

Steve Barrow, Head of Standard Bank G10 Strategy, said the other issue is quite simply the phenomenal growth of financial markets over recent decades. Much of the funding for investors’ positions in assets comes through the FX swap market, which has also grown massively. If we assume that investors like to borrow in the cheapest currency, then this puts the yen in the spotlight, and we have seen this in the past when bouts of severe risk aversion have forced investors to pay down yen loans, making the yen soar. But these episodes are few and far between, and, much of the rest of the time, this yen funding factor seems likely to weigh on the yen.

“What’s more, we may find that hysteresis causes investors to choose yen funding even when Japanese rates are not significantly lower than other funding rates, such as those in the US. In short, we suspect that far more structural factors are at play in the yen’s weakness, and that the current fashion to blame Fed policy and rate spreads is only a part of the story”, said Steve Barrow.