USD Advances on JPY With BOJ Weakening Currency

A big rally in the Japanese yen USDJPY, +0.05% over the past five weeks has been largely fuelled by the so-called carry trade — profiting from borrowing in lower-yielding currency and buying in higher-yielding currency — but the viability of this strategy as the yen weakens is in question, according to analysts.

Since the middle of June, the yen weakened by 4.5% against the dollar and about 9% against the Canadian dollar, as the Bank of Japan continues with its easy monetary policy while other central banks adopt more hawkish stances.

Tightening by the U.S. Federal Reserve over the past six months pushed the spread between Treasury yields and Japanese bond yields higher, with the current spread between the 10-year bonds at about 230 basis points, hovering near their highest levels in two months.

Japanese Yen Graph July 10, 2017

However, for carry trade to be profitable, the interest rate in the country of the funding currency, in this case Japan, should remain relatively lower, and the currency stable. While the Bank of Japan’s commitment to keeping interest rates at or near zero is unequivocal, interest rates and the yen have had the tendency to rise beyond the central bank’s comfort zone in recent months.

Read: Here’s how a global bond selloff forced BOJ to check a yield surge in JGBs

The move by the Bank of Japan last week to buy unlimited amounts of bonds to keep rates low was in response to the rise in long-term yields, when the 10-year Japanese bond yield briefly spiked to 0.105%. The yield fell to 0.08% after the announcement, and on Monday, the 10-year Japanese bond yield TMBMKJP-10Y, +4.23% hovered at 0.0895%.

Neil Mellor, chief currency strategist at BNY Mellon, suggested that as the economy and inflation in Japan improve, there will be more dissent among Bank of Japan governors about continued accommodation, which could easily push the yen sharply higher, hurting speculators relying on the carry trade.

“Core inflation at 0.4%, while low in absolute terms, is still highest in some time. The output gap is positive in two consecutive quarters and wage growth is at fairly high levels, relatively speaking. All these developments could prompt at least some of the Bank of Japan governors into taking some preemptive measures, sending yen higher,” said Mellor.

Alfonso Esparza, market strategist at OANDA, said that a shift in policy stance by the Bank of Japan is likely to be akin to “death by a thousand cuts.”

“Any shift in policy will be carefully telegraphed to prevent any market turbulence. Or course, there will be overreaction anyway. But despite intraday volatility in the yen it has had the tendency to revert to the mean,” Alfonso said.

via MarketWatch

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza