Home ForexDaily Briefings End of negative interest rates in Japan raises threat of yen volatility

End of negative interest rates in Japan raises threat of yen volatility

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The end of negative interest rates in Japan threatens to bring a new era of volatility for the yen, affecting some of its appeal to international investors and foreign governments looking for a reliable vehicle for obtaining low-cost loans.

Bank of Japan Governor Kazuo Ueda on Tuesday ended a decade of ultra-loose monetary policy and eight years of sub-zero borrowing costs, guiding the overnight rate to a range of zero to 0.1 percent.

But the first rise in Japanese borrowing costs in 17 years – coming at a time when other major central banks are contemplating rate cuts – has the potential to fundamentally change the yen's role in financial markets, investors and investors said. economists.

The Japanese currency has maintained a unique position in currency markets since the 1990s, when the Bank of Japan kept rates low or negative to stimulate economic growth and prevent deflation. This has helped keep the yen stable, trading within a relatively tight range for much of the last 35 years.

“This will be seen as a historic turning point,” said Derek Halpenny, head of research at Mitsubishi UFJ Financial Group. “The Bank of Japan will now depend on the data. In theory, that should mean the yen becomes more volatile. . . Volatility and expectations of further rate hikes in the future [make] the yen is less attractive.”

The yen's stability has made it the currency of choice for investors engaging in carry trades, whereby an investor borrows in a low-yielding currency to fund investments in higher-yielding currencies and assets. It has also served as a preferred financing route for governments and companies in times of crisis, with many of them issuing so-called “samurai bonds” in yen in the Japanese market.

The currency also often recovers during times of stress in financial markets, when investors abandon their riskiest trades and return the Japanese currency they borrowed to finance them.

Analysts said the dynamic could change as the yen begins to behave more like other major currencies, in response to economic data and its implications for interest rates. In the long term, many believe these changes will allow the yen to appreciate, in line with other economic changes in Japan.

“What's different after this meeting is that the yen now has upside potential,” said Mark Farrington, global macroeconomic advisor at Farrington Consulting.

The change is also likely to affect investors, companies and governments, as they may no longer rely on the stability of the yen for carry trades, nor resort to it during economic turmoil.

“It's not an overnight phenomenon, but the prevalence of the yen for investors and borrowers will decline,” said Jane Foley, head of foreign exchange strategy at Rabobank.

The Bank of Japan's ultra-loose monetary policy is designed to stimulate economic activity and address deflation. But that has pushed the yen to 35-year lows against the dollar in recent months as the Federal Reserve raised rates to combat rising inflation. The yen fell in the days after the Bank of Japan's announcement and on Thursday hit 151.55 yen per dollar, its weakest rate since November.

Still, analysts said the wide difference in the two countries' interest rates still leaves the yen an attractive option for investors, particularly given that the Bank of Japan has signaled it will not raise rates again in the future. nearby.

That makes the near-term direction of the yen against the dollar more dependent on the policy of the Federal Reserve and not the Bank of Japan. The US central bank suggested on Wednesday that it would cut rates to between 3 and 3.25 percent by the end of 2026.

“The big picture here is that the BoJ decision has less impact in a world where the Fed has raised more than five percentage points. It will be difficult for the yen to have a sustained rally without Fed action,” said Jonathan Peterson, senior market economist at Capital Economics.

Shusuke Yamada, head of Japan currency strategy at Bank of America, argued that companies and investors would still take advantage of the yen carry trade for the time being.

Japanese companies will likely continue to use cheap yen financing to expand overseas, and Japanese investors will likely proceed to sell yen to buy U.S. stocks in a version of the carry trade, Yamada said.

But if Japanese government debt becomes more attractive, then “the appetite for overseas operations could decline for Japanese domestic institutions such as life insurers and banks,” Yamada added.

The biggest impact of the BoJ's historic decision may be felt by governments that have issued yen-denominated bonds.

Since 2022, a wave of heavily indebted African countries, including Kenya and Egypt, have issued samurai bonds, as high interest rates and rising debt burdens have essentially locked them out of other capital markets over the past few years. two years.

Line chart of year-on-year percentage change in non-bank borrowing by currency showing that borrowers tend to move away from the euro and US dollar and towards the yen during economic crises.

“Much of the debt has been at a fixed rate, so [the BoJ’s decision] It is unlikely to affect the majority of current borrowers,” said Elvira Mami, senior economic analyst at the ODI think tank.

“But if the Bank of Japan's decision caused the yen to appreciate, it would be more costly for some.” [developing] countries to pay their debt.”

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