The Yen’s historic 24-year low against the US dollar has been a much-debated topic since the currency began its decline in early 2021. The trigger has been consistent with the timing of the divergence in inflation and interest rates between Japan and the US. Nevertheless, the Bank of Japan (BoJ) has maintained its ultra-easy monetary policy stance despite the jump in inflation which they argue is transitory and largely imported due to higher energy prices. According to BoJ, once the boost from higher commodity prices fades, pricing pressures should ease especially since economic growth is still weak post the COVID-19, output gap remains negative and wage growth far from being robust.
A further decline of the Yen is a possibility if rate differentials continue to be a key driver with global central banks doing more hikes, leaving the Yen the sole funding currency for the whole world. Additionally, given the Ukraine-Russia crisis’ impact on higher energy prices, Japan needs more foreign currency to pay for its energy imports, a fundamentally negative dynamic for the Yen. Still any shift in BoJ’s policy will likely depend on the extent of Yen’s depreciation going forward and how much of a burden the rise in import prices becomes for some companies and consumers.
That said, the deteriorating US growth outlook has led markets to anticipate a US recession next year. Should the US Fed become less hawkish and/or should the BoJ capitulate to allow its yields to rise from the zero-bound, this would result in the narrowing of the US and Japan interest rate spread, which should support the Yen.
While the weaker Yen is a headwind for domestic companies that import raw materials, it is a boon for exporters, especially auto names. Exporters typically forecast the Yen at 115-120 in their forward earnings plans and the year-to-date foreign exchange moves do not yet seem fully priced into market valuations. We are not currency traders and forecasting accurately is impossible, however at the current level, there is an opportunity, in absolute return terms, for international investors to benefit from a Yen rebound. Eastspring’s Japan equity team notes that domestic and defensive stocks would likely have the most upside sensitivity to any Yen strengthening.
USD/JPY versus the 10Y rate differential between the US and Japan
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