The rally in USD/JPY has massively accelerated in recent weeks as markets and the Fed have become increasingly hawkish on U.S. interest rates.
This has happened at a time when many central banks are heading in that direction, even the European Central Band, which at one point looked years away from interest rates above 0%. While it hasn’t yet conceded on the kind of rate hikes that the markets are pricing in, they’re certainly heading in that direction.
The Bank of Japan is the outlier here. Inflation is higher, but core remains stubbornly low, meaning the pressure on the central bank to raise rates is basically non-existent. But rather than allow policy-makers to sit back and bask in their good fortune, being the outlier has presented other challenges, most notably around the central bank’s yield curve control (YCC) policy.
When central banks around the world have rock bottom interest rates, maintaining YCC is quite straightforward. Rates may fluctuate a little but, broadly speaking, keeping them within certain limits poses no major threats. When yields around the world are rising and countries are experiencing high inflation, suddenly Japanese government bonds start seeing their yields rise in tandem, and the BoJ is forced to defend those caps, which can pose some problems, as we’re seeing.
At a time when the U.S. is raising rates aggressively, the BoJ is being forced to buy unlimited Japanese government bonds in order to keep a cap on yields, which is sending USD/JPY soaring. In some ways, this is good for Japan and its exporters. In other ways, it’s not so good as it also imports a lot, including energy, which is already very expensive right now. But the general rule of thumb for policy-makers is there is no defined good or bad level for currency, rather a belief that the speed of those moves matters much more. Rapid appreciation or depreciation (as we’re now seeing) can be problematic.
So the recent moves have prompted speculation that something needs to happen. That could be FX interventions from the Ministry of Finance or a shift in the YCC policy from the BoJ, perhaps widening the band or lifting the level it wishes to hold the yield around.
From a technical perspective, the USD/JPY pair has quickly risen to a level where it has previously backtracked from, both in 2007 and 2015. It’s this knowledge that may have contributed to the profit-taking we saw yesterday and today. A move above here would be a potentially massive step and may make the ministry of finance and BoJ nervous.
A move below the ascending trend line could signal a deeper corrective move, although that could quickly attract interest given the scale of the move that preceded it. Signs of either of the previously mentioned measures could see that wane but until then, things could get uncomfortable for policymakers as the divergence between Japan and most other countries continues to widen.
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