The yen seems to have finally stabilized and taken a generally slight strengthening bias, which has left the USDJPY generally trending lower. But there are several major events on Friday that could significantly shake up the yen in particularly the Yen carry trade.
Those events include, BOJ Governor Kazuo Ueda’s speech (and questioning) before Japan’s Parliament, the release of Japanese CPI data and the potential effects from Fed Chair Jerome Powell’s Jackson Hole comments. All of them have a chance of batting around the yen, as investors have largely been holding pat in anticipation of potentially large moves going into the weekend.
The BOJ’s Impossible Position
The crash in Japan’s markets (and subsequent recovery) have left the BOJ in an even worse blind than it was before. Before August, Japan’s central bank was dealing with rising inflation due to a weakening currency, but was cautiously trying to raise rates to head off inflation without causing a market collapse. But, in order to reassure the markets after the August 5 “black Monday” event, the BOJ essentially promised to not raise rates.
This means that the market is essentially “deanchoring” inflation expectations, which could send CPI soaring. “Deanchoring” is central bank speak for an economic theory that inflation is more related to how “anchored” the market’s expectations for prices are. What “anchors” inflation expectations is confidence in the central bank’s will to raise rates to control consumer prices. But if the BOJ won’t raise rates, then the anchor for prices is essentially gone.affecting the Yen carry trade dynamics.
Weaker Yen Ahead?
Usually, high inflation implies that a currency will gain strength, because the central bank will try to lower inflationary pressures by raising rates. Otherwise, the currency will lose value as it is eroded by inflation. With the BOJ limited in its actions, the market might start expecting higher inflation and lose interest in the yen.
But “normal” doesn’t really apply to yen, because of the estimated $1.2 trillion in yen carry trades .They have already weakened the yen beyond what would be the “normal” effects of inflation. Which is why what happens in Wyoming could be more important for the yen than what happens in Tokyo. The yen carry trade relies on higher interest rates in the US.
Unraveling the Carry Trade
The BOJ essentially committed to fixed rates, so the variance in rates now relies on the Fed. The FOMC minutes showed the Fed has turned dovish, and a particularly dovish message from Fed Chair Jerome Powell in his Symposium address could cause expectations for further easing from the Fed. The closing interest rate gap would mean more buying of yen and selling dollars as carry traders close out their positions. That would ultimately mean the yen gets stronger in spite of the indications that would normally weaken a currency.
One of the potential events that could change that narrative is if Ueda backtracks on the commitment to keep rates steady. Politicians are likely to press Ueda on why the BOJ did what the politicians were pressuring it to do in the first place: Try to stop the fall of the yen. But, at the current rate, the Fed is doing the job for the BOJ, so there is likely little need to suggest there will be more tightening in Japan. For now.
