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The limits of yen intervention

by SuperiorInvest

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Japan's intervention in support of its currency has proven to be a bit like the labors of Sisyphus. Traders suspect that the Japanese Finance Ministry has used $59 billion to boost the yen from a record intraday low of ¥160 to ¥153 per dollar two weeks ago. But as of Wednesday, the Japanese yen is back trading at around ¥156 per dollar, and may fall further.

Like Sisyphus's boulder rolling down a hill, the yen's fall was entirely predictable. It highlights the general futility of unilateral monetary intervention. The economic fundamentals that had boosted the dollar and dragged down the yen are still in play. Although the Bank of Japan's March decision to end negative rates generated publicity, the rate was only raised to 0.1 percent, and the Bank has been cautious about future rate increases. With stronger-than-expected inflation pushing the Federal Reserve to keep U.S. rates at 5.25 percent longer, elevated U.S. yields mean the dollar will put pressure on the yen and other currencies until U.S. rates come down This makes unilateral price interventions useless.

This is not the first time in recent history that Japan has intervened in currency markets. The Finance Ministry intervened three times in late 2022, spending a combined $58.7 billion as the currency fell below 150 yen to the dollar. The effects of those interventions were also only momentary. The yen's strengthening over the following months was driven by a drop in US Treasury yields, not by actions by Japan's Ministry of Finance.

Japan's recent preference for a stronger yen is not surprising. Given its economy's increasing dependence on energy and food imports, a stronger yen increases Japan's purchasing power in the international market. It also supports household savings, which are critical for Japan as its population ages and households become increasingly dependent on their coffers. The need to support the currency may also stem from lingering fears in the run-up to the 2008 financial crisis. Then, a stretch of yen weakness masked underlying economic vulnerabilities, causing great pain as the global financial system faltered and the yen rose sharply. Politics are also at play, as Prime Minister Fumio Kishida and his government fear that economic instability is suppressing consumption and alarming the public.

Yen to Dollar line chart showing that the yen weakened against the dollar after each successive intervention in 2022

However, focusing on the yen's strength may be misguided: for now, there are benefits to having a weaker currency. At the Bank of Japan's March meeting, the monetary policy committee extolled the return of a “virtuous inflationary cycle,” as rising wages appeared set to revive inflation after decades of price malaise. But Japanese inflation has since slowed. As mentioned at last week's BoJ policy meeting, a weaker yen could quickly spur price growth, allowing the BoJ to meet its inflation target.

While Japan's dissipation of $59 billion shows that unilateral monetary intervention is fruitless in the long run, the short-term effectiveness of any intervention comes down to its objective. The yen occupies a unique place in the global market, as decades of ultra-loose monetary policy have made it the favorite vehicle for the carry trade, which in turn suppresses the yen. Given Japan's large foreign exchange reserves, a one-time intervention could be seen as a rational and affordable warning from the Japanese government to currency traders to restrict their speculation.

But Japan should rest there. Until the fundamentals underlying the weak yen dissipate, burning more reserves just to send more signals to traders (who in turn can leverage future price interventions to their advantage) is likely to be an exercise in Sisyphus.

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