Weakness of Yen Reflects Interest Rate Difference, Poses Valuation Challenges

Explore the factors behind the weakness of the yen and its impact on global economies. The valuation challenges arise from the interest rate difference between Japan and other markets. Gain insights into the concerns of investors and policymakers surrounding this devaluation trend.

The current weakness of the yen has been a topic of concern for investors and policymakers alike. As the exchange rate between the Japanese yen and the US dollar continues to decline, experts are analyzing the factors driving this devaluation and its potential impact on the global economy.

The exchange rate of the Japanese yen on September 7 reached its lowest level since the beginning of the year, raising concerns about the possibility of it falling even further. With the yen at risk of reaching last year's "bottom" of 151.94 yen for 1 USD, the Japanese government has started expressing its intention to intervene and stabilize the currency. However, experts argue that the yen's current weakness is primarily driven by interest rate differentials between Japan and other global markets. This poses a significant challenge in preventing further devaluation in the near future.

One significant factor influencing the selling of yen is the widening interest rate gap between Japan and foreign markets. The US non-manufacturing purchasing managers index for August, published by the Institute for Supply Management, surprised the market with its higher-than-expected results. This has potentially provided the impetus for the US Federal Reserve (Fed) to consider raising interest rates, thereby creating a strong motivation for investors to sell off yen and buy US dollars. As of September 7, the exchange rate between the yen and USD was approximately 147 yen for 1 USD.

While the Bank of Japan (BoJ) continues to maintain an ultra-loose monetary policy with negative short-term interest rates, central banks worldwide have been raising interest rates since last year to curb inflationary pressures. According to JPMorgan Chase Bank, the interest rate differential between Japan and the global average has reached a staggering 4.8 percentage points. This exceeds the spread observed during the peak of yen trading in 2007 when investors borrowed yen at low interest rates to seek profits from stronger currencies. In fact, this is the largest difference recorded since 2001 when the BoJ implemented quantitative easing measures alongside the zero interest rate policy.

By contrast, in 2000, the US Federal Reserve raised interest rates to 6.5% in an attempt to address the dotcom bubble, which resulted in the crash of technology company stocks traded on the internet with the domain name ".com."

Reflecting on the current scenario, in July, the value of internal foreign bank branches' accounts engaged in trading transactions in Japan reached a total of 10,000 billion yen. However, this figure is still less than half of the peak reached in 2007, indicating significant room for further expansion of trading. Such expansion would likely weaken the yen even further.

According to estimates by the US Commodity Futures Trading Commission, speculators have been consistently selling the yen since March 2021. This selling momentum remains strong, making this yen selling cycle the second longest since 2000. The longest cycle, stretching from 2012 to 2015, coincided with the implementation of the "Abenomics" economic policy and the super-easing policy by the Bank of Japan.

While the Bank of Japan appears less concerned about the yen's devaluation and continues its ultra-loose monetary policy, Japanese government officials remain wary of a prolonged decline in the yen's value. The Deputy Minister of Finance in charge of international affairs, Masato Kanda, has affirmed that they are closely monitoring the situation. Should any speculative activities violate basic economic principles, the Japanese Government will intervene to the best of its abilities.

In conclusion, it is evident that the current weakness of the yen is a complex issue influenced by various factors, with the interest rate differential between Japan and other markets being a key driver. Despite the Japanese government's efforts to intervene, experts anticipate challenges in preventing further devaluation of the yen in the near future.