Yen Faces Headwinds That Damp Any Advantage From Fed’s Big Cut
(Bloomberg) -- The yen is facing a multitude of negatives that seem to be outweighing any advantage it’s gained from the bumper Federal Reserve interest-rate cut.
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Japan’s currency stayed under pressure Tuesday morning in Tokyo, after the worst week in almost five months. Chair Jerome Powell’s caution about the pace of easing raised the question about whether yield differentials will narrow enough to support the yen, even after the Fed slashed its policy rate by half a percentage point. Meanwhile, Bank of Japan Governor Kazuo Ueda appeared to be in no rush to hike rates again.
The yen has appreciated 12% so far this quarter against the dollar, the best performer among 17 currencies tracked by Bloomberg. Still, investors have no difficulty in finding reasons why the rally may prove to be short-lived, ranging from capital flows to investor positioning.
These four charts show why:
Prospects of tepid economic growth and Japan’s aging population have been encouraging local money managers and companies to invest elsewhere, even after the BOJ brought its negative-rate policy to an end. While purchases of foreign bonds have slowed this year, direct investment eclipsed the decrease to keep the overall outflows at a robust ¥9.42 trillion ($66 billion).
The situation is similar to Japan’s trade balance. Deficits have shrunk from a peak reached in 2022, but have remained below zero for three years on a seasonally adjusted basis.
“The underlying trend is yen selling,” said Kazushige Kaida, head of FX sales at State Street Bank & Trust Company’s Tokyo branch. “Many Japanese investors think excess return can be earned not inside, but outside Japan.”
Japan’s entire yield curve is still below the nation’s inflation rate even after the BOJ started tightening policy. This is in a sharp contrast to other major economies such as the US where so-called real yields are positive, making these markets attractive destinations for Japanese money.
The Fed’s outsize cut on Sept. 18 was also seen as Powell’s attempt at ensuring a soft landing for the US economy. That may limit a further decline in Treasury yields and gains in the yen.
“The yen is still susceptible to selling because of its negative yields,” said Jun Kato, chief market analyst at Shinkin Asset Management Co. in Tokyo. “Considering that the US economy isn’t in such a state of sudden deceleration, there’s a possibility that the dramatic narrowing of the real interest-rate gap between the US and Japan may be coming to a halt.”
The BOJ left the benchmark rate unchanged at 0.25% on Friday. Ueda said upside risks to inflation from the yen’s weakness were easing and that gives him room to consider policy.
Doubt over the sustainability of the rally may prompt speculators to rethink their bullish yen positions, which reached the highest since 2021 this month. Japan’s low interest rates relative to others mean investors incur losses on the long positions unless the currency gains sufficiently to offset yield differentials.
“It’s unlikely that speculators will build more yen longs from here,” said Hideki Shibata, a senior rates and foreign-exchange strategist at Tokai Tokyo Intelligence Laboratory Co. in Tokyo. “The market has already factored in a considerable degree of Fed rate cuts. The pressure to buy the yen due to the difference in real interest rates between Japan and the US may have already peaked out.”
--With assistance from Saburo Funabiki and Masahiro Hidaka.
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