Hey…has anyone else noticed Japan’s safe-haven currency is starting to get the jitters?
Link copied to
The slow motion car crash that is the Japanese Yen continues. It’s headed for the bridge and currency analysts are worried nothing can stop it this time and that has repercussions for all of us, cos there’s a basket of currencies in the back seat.
Traditionally the Yen has swayed to its own beat. It’s often been a bit of a safe haven currency – a good place to land when your capital flight if weighed down with risky assets. Likewise, when the Yen is under pressure, it’s a sure fire indicator of a rising demand for risky assets.
But that explanation hardly fits with what is happening now, according to FxPro senior market analyst Alex Kuptsikevich.
He says it could be time for markets to make a ‘significant reassessment’ of Japan’s position in the financial system.
“In a worst-case scenario, this may turn into a debt crisis in the Land of the Rising Sun,” he said.
But it won’t stay in the archipelego, Kuptsikevich warns.
“This could be an even bigger disaster for financial markets than the eurozone debt crisis of a decade ago.”
A peaceful time it was, a hallowed time.
A time when in demand equities ran free and were still an attractive domain for capital to flow and boost the purchasing power of investments.
That tap was suddenly turned off when Russian tanks rolled into Ukraine, but accelerated in the last couple of weeks on signs that these events have hyped up the processes that were taking place before.
Even before the COVID-19 pandemic, Japan was an absolute laggard when it came to maintaining a sliver of fiscal discipline.
But a concerted effort in the five years leading up to COVID-19 to slash the fiscal deficit, led government debt to stabilise at around 235% of GDP. Okay. That’s still twice as much as the Americans, and about six times as much as Australia’s last read.
“These processes are now most visible in the dynamics of the Japanese yen against those currencies where the central bank can respond adequately to inflation,” Alex Kuptsikevich notes.
Since the start of February, the USDJPY has risen by 6.5%, and almost all of this increase has taken place since March 7th, taking the pair back to levels last seen at the end of 2015.
A much more impressive rally is taking place in the Aussie and Kiwi against the Yen. Since the start of February, they have soared by more than 12%.
So far this month, the strengthening is the largest in 11 years for AUDJPY and in more than 12 years for NZDJPY.
“The interest rate differential game,” Kuptsikevich says, “which was so beloved by traders in Japan before the global financial crisis, has found a second life.”
Because nations like Australia and New Zealand with an entirely different economic structure and monetary policy settings, have the economic potential to raise interest rates.
Like us, even the Kiwis are enjoying a maetrial filling of the coffers, as export prices boom.
The Fed keeps warning it will need to roll out the big guns in its battle against inflation. Traders have priced in faster rate increases to reflect this shift but the USD hasn’t really come out the winner as expected.
Instead, it is the yen that has suffered.
Fedspeakers keep hammering it home – ‘whatever it takes’ – they say, to cool inflation, nothing is off the table.
That means raising interest rates as quickly as possible to slow down the US economy and it is an on point message which has played out across global markets.
Treasury yields went through the roof, Peter McGuire CEO at XM says.
“They’ve eclipsed pre-pandemic levels as traders scrambled to price in faster tightening.
With US yields powering higher, one would have expected the dollar to bulldoze its way through the FX arena. Another seven and a half quarter-point rate increases are now baked in for this year, which would push the federal funds rate to around 2.25% by December.
But that hasn’t been the case.
“Instead of the dollar strengthening, it is the yen that has been demolished,” McGuire says.
“When the Fed hits the brakes, everyone else is expected to follow suit. Even in Europe, traders have cranked up their bets for rate hikes lately, propelling European yields higher. While the ECB will be slower than the Fed, this repricing has been enough to negate the impact on euro/dollar.”
But the Yen is the exception to this rule.
The harried Bank of Japan (BoJ) is the only major central bank that’s not expected to raise rates this year. It also remains committed to its yield curve control strategy, which prevents Japanese yields from rising beyond a certain level and therefore makes the yen less attractive as foreign yields soar.
While supporting the economy remains a priority over the fight against inflation, BoJ policymakers were paying more attention to rising inflationary pressures even before Russia’s invasion of Ukraine a month ago today.
Kuptsikevich says the situation in Japan is more alarming than business as usual.
“As Japan’s debt-to-GDP ratio has risen by 77 percentage points to 170% since the financial crisis. Permanent QE from the Bank of Japan has kept government debt costs down, but doesn’t solve the problem,” he said.
In the last ten years, Japan has turned into a net commodity importer due to its growing dependence on energy and metals and increasing competition from China and Korea.
The soaring cost of essential commodities – fuel and grain for a start – are adding enormous pressures to the resource-poor island-state by hoisting import costs, expanding the trade deficit and slapping a massive question mark on the BoJ’s hope that it is going to be able to land the world’s third-largest economy onto a nice, moderate recovery.
Kuptsikevich doesn’t see this smoothly going to plan. He says in this situation, usually, the exchange rate should act as a natural mechanism to stabilise trade.
“But this adjustment is difficult for debt-laden 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 accept that it will finance the government (i.e. increase purchases despite inflation) or soften QE (i.e. dial back the stimulus).
“The first option risks triggering a historic revaluation of the Yen,” Kuptsikevich warns. “The second option would deal a blow to the economy and finances by raising questions about whether Japan can service its debt.”
At last week’s meeting, the central bank downgraded its economic outlook, and with risks still unexplored a month into the Ukraine crisis, the bank made clear it was in no rush to dial back stimulus.
Because there isn’t another option.