Summary of Key Points
The Japanese yen has recently plummeted to a new low since 1986 (1 US dollar to 162.4 yen), and the market is closely watching whether Japan will intervene in the foreign exchange market again. The Bank of Japan raised interest rates to 1% in June, the highest level in 30 years, but due to the large interest rate gap between the US and Japan, the downward pressure on the yen has not diminished. Intervention can only temporarily alleviate the depreciation and cannot change the long-term trend. Although raising interest rates is intended to support the yen, it may lead to a tightening of global liquidity, limiting policy options.
The Main Cause of the Yen's Continuous Decline: The US-Japan Interest Rate Gap
The primary reason for the yen's depreciation is the significant difference in interest rates between the US and Japan. Simply put, current US interest rates are around 5%, while Japan has just raised them to 1%, a difference of 4 percentage points. Investors borrow yen at lower interest rates to exchange for US dollars to buy high-yielding assets (such as bonds) in the US, earning the profit from the spread—this is known as "arbitrage trading." As more people sell yen and buy dollars, the value of the yen naturally declines.
Even if Japan raises interest rates, as long as the interest rate gap remains, arbitrage trading remains profitable, and the downward pressure on the yen will not disappear. For example, if you borrow 1 million yen with an annual interest cost of 10,000 yen, you could exchange it for US dollars to buy US bonds and earn an additional 50,000 yen in a year—wouldn't you do the same?
Will Japan Intervene to Save the Yen? Possibly, but with Limited Effect
Japan has already spent 11.73 trillion yen on intervention (in April and May), but the yen has still declined. The market is focusing on two key factors:
1. Verbal warnings vs. actual intervention: Finance Minister Toshimasa Katayama says Japan is "prepared to act at any time," but only mentions "bold action" when questioned, suggesting that verbal warnings are likely to come first before actual intervention.
2. A critical level: 164-165 yen per US dollar is the next "red line"; if the yen falls below this level, Japan may intervene by buying yen and selling dollars.
However, even if Japan intervenes, the effect will be limited. An expert from Nomura Securities argues that intervention can only cause the yen to rise slightly in the short term; the underlying issue of the interest rate gap remains unresolved. It's like trying to stop a rolling ball—you might stop it for a moment, but the slope is still there, and the ball will eventually roll down again.
Why Are Central Bank Rises in Interest Rates Ineffective?
Japan's raise in interest rates to 1% in June was the highest in 30 years, but the market reaction was lukewarm. Why?
- The increase is too small: A 25-basis-point (0.25%) rise has little impact on the large interest rate gap between the US and Japan.
- The market does not believe in sustained rate hikes: Japan's economy is fragile, and higher interest rates could increase borrowing costs for businesses, potentially slowing economic growth. Therefore, the market believes the Bank of Japan is reluctant to raise rates continuously. For example, a five-star investment firm is still "shorting" the yen, indicating that investors do not believe rate hikes will help the yen.
An expert from Wells Fargo suggests that for the yen to strengthen, the Bank of Japan would need to clearly state that it will continue to raise rates and convince the market of this—though this seems unlikely at present.
The Impact of Yen Depreciation on Japan
The yen's depreciation has mixed effects domestically:
- Exporters are happy: Japanese cars and electronics sell well abroad, and the increased profits from selling US dollars for yen contribute to the strong performance of the Japanese stock market.
- Consumers are worried: Goods like oil and natural gas are priced in US dollars, so a weaker yen means higher costs for these items. For example, what used to cost 100 yen for imported milk might now cost 120 yen.
The Japanese government is in a difficult position: it wants to support exports while controlling inflation, and intervening in the foreign exchange market is a way to balance these two goals.
The Side Effects of Raising Interest Rates
Rising interest rates in Japan affect the global market:
- Arbitrage trading liquidation: Investors who borrowed yen to buy overseas assets may sell them and convert back to yen (either because the yen might appreciate or because borrowing costs increase with higher Japanese interest rates). This reduces the amount of money available in the global markets, leading to a tightening of liquidity.
- Stock and bond markets are affected: With less money available, stock prices may fall, especially for companies with high leverage. Bond yields can become more volatile, and borrowing costs rise.
A report from Hongli Investments suggests that the resulting liquidity contraction could offset the positive effects of SpaceX's IPO and declining oil prices, making the global market more cautious due to Japan's interest rate hike.
In conclusion: The core issue is the large interest rate gap between the US and Japan. Both intervention and rate hikes are unlikely to change the long-term trend. The Japanese government is caught in a dilemma, trying to support the yen without harming the economy. The global market must also be cautious of the potential risks of a liquidity shortage caused by Japan's interest rate hikes. For laypeople, this means that the yen is weakening because US interest rates are much higher than Japan's, and while Japan wants to stabilize it, it may not be able to do so without affecting the global economy.