Major currencies have seen fluctuating performance in recent months. USD performance has ebbed and flowed, with major currencies often reacting in line with swings in risk appetite. However, there is one currency that has failed to take part in these moves. That is the perennially underperforming Japanese yen. The record levels of weakness that the JPY has been reaching are leading to speculation that currency intervention may not be far away. Forex traders should be prepared.
- Monetary policy divergence continues to drive JPY weakness
- The initial signals of intervention are appearing
- Record levels of JPY weakness are being seen on its major crosses
Bank of Japan policy divergence weakens the JPY
The past 18 months have seen record monetary policy tightening from the world’s major central banks. Aggressive rate hikes have seen central banks increasing interest rates by 400 to 500 basis points.
However, compared to this, the Bank of Japan is moving at a glacial pace. The deposit rate remains at -0.10%, whilst only the most minor tweak to the yield curve control band (from +/-25 bps to +/-50bps) for the 10-year Japanese Government Bond yield around zero has been seen. A policy review was announced at the end of April over the next 12 to 18 months but as yet no substantial move in monetary policy. The first move would likely be to remove the YCC on the 10-year yield and then to push ahead with an increase in interest rates. However, for that, we wait.
This monetary policy divergence from other major central banks has driven significant weakness in the Japanese yen. The chart below shows performance in the past three months versus the USD. You can see that JPY has continued to consistently lose ground.
Other major currencies have fluctuated and are now mostly up versus the USD. The JPY has underperformed the USD by almost -9%. Measured against the top performers (CAD and GBP) the underperformance is between -13% and -14%.
Currency intervention has an impact
Judging by how the JPY is performing on its major crosses, there is a real likelihood that intervention could be approaching, but we are not there yet. The last currency intervention from Japan came in October/November 2022 as the yen weakened above 150 versus the USD. Due to the weakness of the USD recently, USD/JPY is still around 143.
However, against other major currencies such as the EUR and GBP, the JPY is already trading at record weakness. EUR/JPY is at its highest since 2008, whilst GBP/USD is at its highest since 2015.
In the intervention around 8 months ago, the Japanese authorities delved into its vast pool of foreign exchange reserves (c. $1.2 trillion at the time) to prop up the ailing yen. The moves eventually turned the tide of JPY weakness and the currency began to strengthen over the coming weeks.
There were considerable moves lower on XXXJPY pairs, with USD/JPY dropping by over -2000 pips (more than -16%) in a couple of months. Traders caught on the wrong side of this would have felt the pain.
Markets have since settled and the persistent monetary policy divergence has once more taken dominance in driving JPY moves. The renewed JPY weakness once more brings currency intervention back into play.
How close are we to currency intervention now?
If the Bank of Japan changed monetary policy it would be a groundbreaking moment in forex markets and would likely cause significant volatility. However, we still could be months away from this happening. In the meantime, the weakness of the JPY is registering. The selling pressure depreciates the JPY and makes import costs spike higher.
Japanese Government officials are starting to publically talk about the importance of stability in currency markets. Cabinet Secretary Matsuno has said:
“government will closely watch the currency market with a strong sense of urgency and respond appropriately to excessive moves.”
This is a thinly veiled comment about currency intervention. Talking about it is step one. They will see how the market responds and then if there is no stabilization, start to intervene through forex reserves.
Technicals show further upside on USD/JPY
Looking at the technical analysis of the USD/JPY chart, there seems to be further upside in the near term. The bull flag that formed on the breakout above the key resistance at 137.90/138.15 implies an upside potential towards 146. Momentum is strong with the move and there is little suggestion that it will not continue higher from here.
A move towards 146 would also be into an area between 145/150 which is considered to be around where the Japanese authorities would likely be considering intervention once more. So, whilst there is a continued move higher for now, it might be wise to be on alert for any signs of a pullback. As I showed in the move from Q4 2022, currency intervention can have a decisive impact on the outlook of a currency. At least for a month or two anyway.
