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Will Japan's Interest Rate Hike Strengthen the Yen Amidst Global Challenges?

BOJ's historic rate hike fails to bolster yen, remaining near three-decade low against dollar despite policy shift.

By Barry Stearns

4/3, 19:18 EDT

Key Takeaway

  • Japan's historic interest rate hike fails to bolster the yen, remaining near a three-decade low against the dollar.
  • Carry trade persists due to Japan's negative real interest rates and global yield gap, undermining efforts to strengthen the yen.
  • Despite a weaker yen, Japanese exports haven't seen significant growth, challenging expectations for an economic rebound.

Interest Rate Hike's Limited Impact

Japan's recent decision to raise interest rates for the first time in 17 years has not strengthened the yen as much as anticipated. Despite this policy shift, the yen remains near a three-decade low against the dollar. Daisaku Ueno, chief foreign-exchange strategist at Mitsubishi UFJ Morgan Stanley Securities Co., notes, "The yen is likely to remain weak," attributing this to Japan's negative real interest rates and the global yield gap. Japan's 10-year yield, when adjusted for inflation, is significantly lower than that of other major economies, such as the US and Germany, making the yen an unattractive investment.

Carry Trade Continues

The low yield of the yen encourages the carry trade, where investors borrow in yen to invest in higher-yielding assets elsewhere. This situation is problematic for Japan, as it exacerbates the cost of living by increasing the price of imports. Although the Bank of Japan (BOJ) is expected to raise borrowing costs further, the timing is uncertain, and it is unlikely to quickly close the yield gap with other countries. Market strategist Ayako Sera from Sumitomo Mitsui Trust Bank Ltd. compares the flow of funds to water, naturally moving from low to high yield areas, highlighting the challenge for Japan to retain investments domestically.

Intervention and Volatility

The possibility of intervention by Japan's Ministry of Finance to support the yen has been a topic of speculation among currency traders. However, the criteria for intervention, such as rapid movements not aligned with fundamentals, have not been met recently, making actual intervention unlikely in the near term. Additionally, the currency market has seen reduced volatility, further encouraging carry trades and bearish bets against the yen.

Export Dynamics and Future Outlook

Contrary to expectations, the depreciating yen has not significantly boosted Japanese exports. This may be due to Japanese companies increasingly producing goods overseas and the outflow of funds seeking higher returns abroad. Steven Englander from Standard Chartered Bank notes the absence of an improved trade balance, which weakens the case for a yen rebound. Looking ahead, a Bloomberg survey of economists suggests the BOJ may raise interest rates again by October, with the pace of hikes potentially accelerating due to factors including yen weakness.

Street Views

  • Daisaku Ueno, Mitsubishi UFJ Morgan Stanley Securities Co. (Bearish on the yen):

    "The yen is likely to remain weak... Despite the rate hike, there’s no prospect to see positive real interest rates in the near term, which makes the appeal of the yen very poor."

  • Ayako Sera, Sumitomo Mitsui Trust Bank Ltd. (Bearish on Japan's financial environment):

    "Surplus funds naturally flow from lower-yield places to higher-yielding countries, just like water flows from high to low... There’s no reason to keep surplus funds here where the policy rate is around zero."

  • Steven Englander, Standard Chartered Bank (Neutral/Bearish on yen rebound prospects):

    "An improved trade balance should be part of the adjustment process for a currency... The absence of such an improvement weakens the case for a yen rebound."