Will the yen’s recovery require more FX intervention?

>> Could conditions be better for the carry trade?

It looks as if USD62.7bn does not get you very far, at least if that’s the money you have spent trying to weaken US dollar/yen. For the Bank of Japan’s intervention in late April and early May seems to have achieved little more than braking the rise in the US dollar. It has not generated a significant rally in the yen. However, in the Standard Bank’s view, the pieces are very slowly falling into place for a recovery in the Japanese currency.

What do these pieces look like? One is tighter monetary policy in Japan, particularly in the shape of higher short-term rates, because low rates in Japan have made the yen a magnet for carry-trade funding.

Another is easier monetary policy in other countries, particularly those where high rates are making them equally magnetic for the carry trade, albeit from the asset side, not the liability side like the yen.

The third is any factor other than monetary policy that makes carry trade favourites weaker, causing carry trades to be unwound.

A fourth factor is higher volatility across assets, particularly currencies, as high volatility is the enemy of the carry trade.

As a last factor we might cite the willingness of central banks to intervene; not just the BoJ to prevent excessive yen weakness, but also other central banks that might choose to try to limit  currency strength.

Where do we stand on all of these factors? On the first hand, we have clearly seen the BoJ end the era of negative rates with its actions at the March meeting. However, the Bank is still buying JGBs and, rightly or wrongly, many see this as a counterweight to higher short-term policy rates that deadens the impact of rate hikes and arguably frustrates any rebound in the yen. But this JPY6tr monthly buying of bonds by the BoJ could be trimmed soon, with speculation that next Friday’s meeting could be a suitable venue.

In addition to this, rates are likely to rise again later in the year. But while higher rates in Japan seem to be a necessity for yen recovery, so too are rate cuts elsewhere, it would seem. This is slowly coming on stream with a number of emerging market central banks and four G10 central banks now engaged in rate cuts. Of course, the key central bank is the Fed, and here we’ve seen expectations for rate cuts shift backwards through the course of the year.

However, the Standard Bank suspected that the market might have become too hawkish about the Fed, having started the year being too optimistic about rate cuts. It thinks the Fed can still cut in September, and if the market shifts more towards this position, as it has been doing recently, it could weigh on US dollar/yen, especially if the Fed validates this shift with a cut. The third factor we cited is any weakness in carry-trade favourites; particularly that which is unrelated to monetary policy.

>> Judging the BoJ’s FX intervention

On this score, it should be noted that two emerging market favourites, the Mexican peso and the rand have slumped recently due to political factors. Now this might prove temporary, but politics and elections are a hot topic this year, and our sense is that political upsets could have the ability to stop the yen’s bleeding against many currencies and perhaps even spark a significant rally. The last two factors relate to higher FX volatility and central bank intervention.

The Standard Bank thinks that both of these could come into play with the most significant election of the year – that of the US. The election itself is a clear source of potential volatility closer to, and after, the November 4^th polling day, particularly if challenger Donald Trump triumphs. Furthermore, there have already been rumblings within the Trump camp that challenging excessive dollar strength could be one avenue to try to reduce the yawning trade deficit, perhaps through FX intervention.

Now clearly, we don’t know what the outcome of the election will be, just as we don’t know about the other factors listed here, like a September rate cut by the Fed. And even if things turn out as we expect the yen’s recovery may remain slow and possibly require more FX intervention. Nonetheless, the Standard Bank expected that the tide was slowly turning and that it should result in a wave that carries US dollar/yen down to the 125-130 range over the next couple of years.