Yen under pressure: Will Japan intervene in the currency market?

Last week, the Bank of Japan(BOJ) kept its interest rate at 0% and continued buying bonds at 6 trillion yen monthly. This decision disappointed the market, which had expected a change in bond purchasing. After the announcement, the yen weakened further. The market is anxious about when the Bank of Japan will act to strengthen the weakening yen.

BOJ Chairman Kazuo Ueda said the bank doesn’t directly control currency rates but noted that changes in the exchange rate can significantly affect the economy and prices. He mentioned that policy adjustments might be needed if the yen’s fluctuations greatly impact these areas. However, he pointed out that the yen’s current value isn’t causing significant inflation.

Although the Bank of Japan could hike interest rates, adjustments would likely be small, perhaps just 0.1%. The delay in the Federal Reserve’s expected rate cut is a far bigger factor in the yen’s weakening against the dollar.

In 2024, a record $8.9 trillion US government debt will mature. Additionally, the Congressional Budget Office (CBO) forecasts a government budget deficit of $1.4 trillion for the same year. Concurrently, the Federal Reserve is reducing its balance sheet by $60 billion each month. With such high-interest rates and a rapid pace of balance sheet reduction, it becomes challenging for the Treasury to refinance this debt. The US is incurring debt service costs amounting to approximately 3.1% of its GDP. Given these circumstances, the Federal Reserve will likely need to lower interest rates this year.

Several Factors Behind the Sharp Decline of the Yen

1. The main reason for the yen's weakness is the difference in interest rates between the US and Japan. The yen began to weaken particularly after the US initiated a rapid cycle of rate hikes.
2. According to analysts at Deutsche Bank, over 20 trillion yen is involved in carry trades. The yen is a popular currency for these trades due to Japan's low-interest rates.
3. The structure of Japan's balance of payments, which tracks transactions of goods and services with other countries, has changed. Now, earnings from overseas investments are often reinvested abroad and do not return to Japan, reducing demand for the yen.

Moreover, despite the yen’s depreciation, Japan continues to face a trade deficit, with no increase in export volumes. Industrial production and corporate investment remain weak. Although government revenue has risen due to higher income and consumption taxes driven by inflation, this effectively amounts to a tax increase. Wage growth still lags behind inflation rates.

On a positive note, Japan's services sector benefits from increased foreign demand from the weaker yen. Hotels are fully booked, and tourist spots are bustling.

Japan's top currency official, Masato Kanda, described a 10-yen move within a month as rapid. The Japanese yen has recently weakened by approximately 8 yen per dollar over the last month. However, it declined more than 2% just last week and has fallen over 10% since the beginning of the year. In response, Japanese Finance Minister Shunichi Suzuki stated that he is closely monitoring the currency’s movements and will provide a comprehensive response.

Technical analysis

On the monthly chart, the Japanese yen has traded below 160 against the dollar since 1986. Now, after more than 37 years, the yen has reached 160 again. With the stochastic indicator in the overbought zone and the yen hitting its targeted value, any further weakening could likely prompt the Bank of Japan to intervene.If the Bank of Japan intervenes, the USD/JPY could likely reach the 138-140 range, which corresponds to the 0.382 Fibonacci retracement level from 102 in October 2021 to the present. However, without addressing the underlying factors contributing to the yen's weakness and without coordination from other major central banks, the USD/JPY is likely to climb back to 160.

If the dollar-yen exchange rate rises past 160-165, the USD/JPY could easily reach 200, as few resistance levels exist.

If the Bank of Japan intervenes, the USD/JPY could likely test the 138-140 range, corresponding to the 0.382 Fibonacci retracement from 102 in October 2021 to now.

Without the change in the factors contributing to the weakness of the yen and coordination of other major central banks, the USD/JPY will re-test 160 again.