What does the chart show?
 

This week’s chart shows the exchange rate of the Japanese yen against the US dollar (showing JPY per 1 USD). This highlights how the yen has depreciated to its lowest closing level against the dollar since 1990. The yen has also been the worst performer amongst all major currencies in 2023, returning -13.67% so far. This weakening is primarily a result of wide rate differentials relative to the US where treasury yields increased by over 100 basis points year-to-date. This occurs when investors seek higher yields abroad causing the yen to be sold in exchange for foreign currency. Another factor has been the Bank of Japan’s (BoJ) policy decisions regarding yield curve control (YCC) – an ultra-loose monetary policy tool introduced in 2016 to try and stimulate Japan’s stagnating economy. Earlier this week the BoJ loosened this control by shifting from a fixed 1% limit to a more flexible ‘reference point’, permitting the yield to exceed the limit temporarily. Typically, such a change would be anticipated to bolster the yen, however investors had priced in a more dramatic policy adjustment away from the YCC, resulting in a sell-off pushing the yen beyond 150 per dollar. 

Why is this important?

The persistent depreciation of the yen has been beneficial for Japanese companies selling goods internationally, as it improves the competitiveness of their exports. This factor coupled with an accommodating monetary policy has supported the gains in Japanese equities in 2023. The BoJ however will be mindful of the yen weakening excessively which would drive up imports costs and increase inflation, and therefore may be inclined to tighten policy to prevent this. Due to the unconventional nature of the BoJ’s approach to monetary policy, juxtaposing all other major central banks, any tweaks in policy may have significant ramifications on global markets. Since the inception of Japan’s ultra-loose YCC policy, Japanese investors have allocated over $3 trillion abroad in pursuit of higher returns on foreign rates. Therefore, if the BoJ allows domestic yields to push higher, a rapid influx of funds onshore could cause significant disruptions to bond markets overseas where holdings have accumulated. Historically the yen has been considered a ‘safe haven’ currency, a perception which has somewhat broken down recently, but can provide a diversification layer against a potential recession and serves as a hedge for downturns in Japanese equity markets. In addition to monitoring the BoJ’s decisions investors should also pay attention to the strength of the US economy. This will help predict movements in treasury yields and the spread with Japanese government bonds, which will significantly influence the direction of the yen against the dollar.