After months of speculation from currency traders, the Bank of Japan confirmed that they did a currency intervention to strengthen the falling Japanese Yen. The Bank of Japan confirmed its first currency intervention since 2022 with $62 billion being used to prop the Yen between April 26th 2024 and May 29th 2024.
Here was the result:
Large red candles with USDJPY rejecting the 158.20 zone and the wick hitting highs of 160.20. Clearly, it seems that the zone between 158-160 is the line in the sand for the Bank of Japan.
So the Central Bank won right? They beat all of those currency traders and speculators because they instilled the fear that they will intervene to prop the Yen.
Wrong.
Here is what the Yen is doing now:
Today’s price action is setting up for a breakout above 158 and the previous candle highs. 160 is likely to be tested again. That $62 billion currency intervention did not do much. It was not enough to reverse the trend.
The reason is quite simple. Interest Rate differentials. Interest Rates around the world are higher than Japan’s. In foreign exchange world, money tends to buy currencies with a higher rate versus the one with the lower rate. As a trader, you make money on the interest rate differentials called an overnight swap. The US Fed Fund rate is around 5%. Japan’s is 0%, being the last negative interest rate policy nation to get back into the positive. You can see the major difference in terms of rates.
From a fundamental standpoint, shorting the Yen is the free money trade. Currency traders will continue to short the Yen as long as fundamentals do not change.
The Yen is getting smashed against most currencies: CHF, AUD, NZD, CAD. Take your pick on how you want to short it.
So what can the Bank of Japan do? Well they can continue to waste their foreign reserves in order to do currency interventions hoping traders will get the point that the Bank of Japan is serious in defending this level. Perhaps we will see this again shortly in the coming days. However, the fundamentals do not change and traders will continue to short the Yen on drops.
The other option is for the Bank of Japan to adopt a hawkish stance hinting at interest rate hikes. This hasn’t been taken too seriously given the large rate differentials, meaning the Bank of Japan would have to initiate a cycle of multiple rate hikes in order to shift the trend.
And we are beginning to see this. In the most recent Bank of Japan policy meeting, rates were left unchanged but the Bank of Japan did mention it would begin to “significantly” scale back its $38 billion monthly bond buying programme... even though this is a critical milestone in unwinding its ultra loose monetary policy, the Yen weakened on the news because the central bank put off specifics for purchases until next month.
Now, the Bank of Japan is signaling a chance of a rate hike in July, taking rates from 0% to 0.25%. Central Banks tend to use hawkish rhetoric to move prices of the currency with the final option being an actual rate hike. But because the rate differential is so wide, the Bank of Japan really needs to go hawkish. Plus there is the fact that a weaker Yen is driving Japanese inflation higher. They really need to act.
OR other western central banks need to go more dovish with multiple rate cuts. This seemed the case, but the Fed has shifted that in its last meeting now stating they expect only 1 rate cut this year. Just once. This is when analysts were calling for 3 or 4 cuts this year.
So why does this all matter to those who are not currency traders? Sure, there is a chance of a financial/banking crisis in Japan which could go global as rates rise because of this:
But I believe the debt markets are to watch. Those who read my work here on Equity Guru, know I have been sounding the warning bells when it comes to the Bank of Japan and the debt markets.
In previous articles, I have stated that Japan, not China, is the largest holder of US debt. Yes, the Chinese have been dumping US debt, including a record sell off of $53.3 billion worth of treasury’s. But things could get even more shaky in the US debt market if Japanese debt begins to be sold off. By the way, this all comes when a recent US debt auction came in as a flop.
With Japanese interest rates being in the negative for such a long time, Japanese money (remember those Japanese boomers?) had to look elsewhere for yield. Japanese money has been buying foreign debt. In a way, doing indirect yield curve control for foreign nations. Simply put, if Japanese money was to sell off foreign debt to come back to Japan, it would cause yields to spike, leading to a rise in rates, as bonds are being dumped.
As of yet, there is not a large incentive for Japanese money to sell foreign debt. But if the Bank of Japan was to normalize rates… money could return to Japan. The large debate among contrarian investors is what rates need to be to incentivize Japanese money to sell off foreign debt. Some say this would never happen because Japan would need to raise a lot to make domestic debt appealing. Others say it would not have to be much, aiming for 1% in BoJ rates.
But with the Nikkei printing record highs, largely driven by foreign money after the Buffett call, you can see another reason why Japanese money may decide to come back home.
In summary, the Bank of Japan remains one of the most consequential central banks for your money. What they do to defend the Yen will have huge effects in the financial world, especially if they begin a hawkish policy. Some are even using the word “Black Swan” when it comes to Japan and what higher rates could do to their banking system. Whatever the case, it is time to watch Japan. But if you are one of my readers, you already knew this.
Happy Trading.