Currency markets (FX) for major currencies are generally stable, slow and extremely liquid. That is why relatively rarely, in the absence of mass shocks or market dislocations, large movements of these currencies are observed. However, in recent quarters, the Japanese yen (JPY) fell at a record rate against the US dollar. USD: JPY has accelerated even more in recent weeks, and the Japanese currency has fallen to a level not seen in many years.
The reason for the sharp depreciation of the yen is mainly due to a clear difference in the political orientations of the Bank of Japan (BoJ) and other major central banks. The US Federal Reserve (Fed) and the European Central Bank (ECB) are moving towards a “hawk” change in inflation control policy. The Bank of Japan’s approach is to maintain its ultra-light policies for longer, given that inflation is not a concern for Japan. Thus, the Bank of Japan will continue to apply negative interest rates, large-scale asset purchases and yield curve control measures that limit long-term interest rates to low levels.
This policy divergence has led to a large outflow of capital from Japan to other developed economies, including the United States, which is putting pressure on the yen. This is due to the fact that Japanese investors are looking abroad for higher returns adjusted for risk. While Japan’s 10-year government bond yields are barely positive, just above 25 basis points (basis points), 10-year US Treasury bond yields are approaching 300 basis points.
Question: Why is the Bank of Japan so “blue”? What is the reason for this policy divergence with the Fed and other central banks?
In our opinion, it’s all about inflation. And Japan stands out among other developed economies when it comes to inflation, especially in recent quarters. Unlike the Fed or the ECB, which is now focused on fighting inflation, the Bank of Japan’s main struggle remains the fight against radical deflation. In fact, despite the recent recovery from the negative threshold, inflation in Japan remains modest, at 1.2% in March 2022.
Japan’s inflation is still well below the 2% target set by the Bank of Japan in 2013. food and energy related to raw materials. Other components of Japanese inflation, such as housing and education, continue to point to subdued price pressures. There are even some reductions in prices for important goods and services, including health care and transportation. So far, the figures support the idea that the “transition” or infection of imported inflation is limited to Japan.
More importantly, for the seventh year in a row, inflation in Japan is below target. The country remains a deflationary trap consisting of low growth, low inflation and high debt. These trends are dominated by other global inflationary effects, such as the recovery in demand after the pandemic and supply chain bottlenecks. Prolonged deflation in Japan has created a “memory” of fixed prices, which has become entrenched in the behavior of households and businesses. This “consolidation of aspirations” creates a deflationary cycle of low cost feedback, low price growth, low wage growth and overall cost vigilance. Only very large and persistent internal shocks could break this dynamic. In the absence of such persistent shocks and new behaviors, inflation in Japan must remain subdued in the short to medium term.
In general, the divergence of inflation between Japan and other developed economies contributes to the creation of a large difference in interest rates between the Bank of Japan and other major central banks, including the Fed. This leads to an outflow of capital from Japan, which puts pressure on the yen. The yen should remain volatile in dollar terms, but more stable stabilization requires either a collapse in global inflation forecasts or significant Bank of Japan intervention in the foreign exchange market.
Posted on 5/23/22 4:36 PM