Ahead of the May Day Golden Week holiday, while exchanging currency for a trip to Japan, Zhao Nan (a pseudonym) was surprised to find that 1 yuan now could exchange into nearly 22 yen, up more than 10% from the year’s start. As of May 30, the yuan has climbed a staggering 46% against yen from its March 2020 low.
The depreciation of the yen has spurred Chinese tourism to Japan, with the country becoming the top destination for Chinese travelers during the Golden Week holiday, as reported by Ctrip and other travel platforms. The Japan National Tourism Organization reported that over 3 million tourists visited Japan in April for the second consecutive month.
The yen’s depreciation has accelerated since April, hitting a record low of 160 yen against U.S. dollar on April 29, the lowest since 1990. The real effective exchange rate also plummeted to pre-1970 levels. Although the Japanese Ministry of Finance intervened, the yen remained around 157.5 yen per dollar by May 30.
The currency’s decline has had a mixed impact on Japan’s economy. On the positive side, it benefits exports and tourism. Yoshiharu Hoshino, CEO of Hoshino Resorts, which operates 62 resort hotels in Japan and overseas, noted unprecedented demand for its properties. Tourism spending surged 73.3% year-on-year in the first quarter, the highest quarterly figure to date. Exporters, which account for more than half of Japan’s Topix stock index, saw profits soar. Bank of America estimated that every additional yen to the dollar in the exchange rate might boost operating profit for companies in the Topix 500, which tracks the largest Japanese companies, by 0.5%.
However, the yen’s decline has also had adverse effects. Japan's GDP shrank by 0.5% quarter-on-quarter and 2% year-on-year in the first quarter. Private consumption and capital expenditure also fell, primarily due to the increased cost of imports including food and energy, which has hurt real wage growth and corporate investment. The weakening yen has become a political issue as it impacts the daily lives of ordinary Japanese.
The slumping yen also affects Japan’s global economic position. Japan’s nominal GDP will be overtaken by India’s and slip from No. 4 in the world to No. 5 next year, largely due to the yen’s depreciation, according to projections by the International Monetary Fund.
The Nikkei 225 index, buoyed by strong export earnings, reached a 34-year high in March, but later faced volatility due to the yen's rapid depreciation. Japanese stocks fell more than 6% by late May, with global investors moving funds from Japan to other markets, including Hong Kong and Chinese mainland.
Several factors contribute to the yen’s decline. The diminished expectations for rate cuts by the Federal Reserve and the Bank of Japan's dovish stance are primary drivers. The U.S.-Japan interest rate gap has spurred global investors to short the Japanese currency.
Opinion is divided over the Japanese central bank’s yen policy. Tatsuhito Tokuchi, former chairman of Citic Securities International Co. Ltd., believes intervention to support the yen is the job of the finance ministry. Former BOJ Governor Masaaki Shirakawa warned that prolonged low-interest rates could hinder productivity by bolstering inefficient firms. In terms of foreign exchange intervention, it is the speed of the yen’s depreciation, rather than defending a specific level, that should be the focus, some experts say.
Most experts agree that the yen’s direction will depend on U.S. economic policies and Japan’s structural reforms. But the yen remains under long-term downward pressure, according to Tadaaki Kawamura, head of financial attaché at the Embassy of Japan in China.
Why yen depreciates?
The yen’s decline against the dollar has been largely due to widening interest-rate differentials as the U.S. Fed raised rates aggressively to combat inflation, while Japan has kept a negative interest rate. The Bank of Japan in March raised the short-term rate from -0.1% to between zero and 0.1% – the first such increase in 17 years.
Japan’s zero interest rate makes yen an attractive currency to short, explained Teck Leng Tan, a foreign exchange strategist at UBS Wealth Management. “The Bank of Japan is undoubtedly the most 'dovish' central bank," reinforcing market sentiment to short the currency, Tan said. The BOJ’s reluctance to raise interest rates despite global inflation pressures has exacerbated the yen’s decline.
Former BOJ board member Takahide Kiuchi observed that the yen’s depreciation is not limited to the dollar but extends to other currencies including the euro, as the Japanese central bank has been reluctant to raise interest rates despite global inflation pressures. The BOJ’s decision to end negative interest rates in late March, while maintaining accommodative financial conditions, failed to halt the yen’s decline. A summary of opinions at the bank’s March meeting showed that many policymakers saw the need to go slow in future rate hikes. The BOJ’s stance at the April 26 meeting was even more dovish than the market expected by maintaining the target interest rate of 0-0.1% while BOJ Governor Kazuo Ueda said the weak yen has not had a big impact on underlying inflation for the time being. In the days that followed, the yen’s decline accelerated.
Speculative activities have also put downward pressure on the currency. Morgan Stanley pointed out that foreign investors have been hedging their Japanese stock investments by buying dollars, contributing to the yen’s depreciation. Additionally, Japanese individuals and institutions investing in foreign assets, as well as companies purchasing digital services abroad, have increased selling pressure on the yen.
Tao Dong, former chief economist at Credit Suisse Asia, pointed out that the wide interest rate differential has fueled significant carry trades, where investors borrow low-yielding yen to invest in higher-yielding currencies. Data from the U.S. Commodity Futures Trading Commission as of late April show that speculative short positions against the yen reached the highest level since June 2007, adding to pressure on the currency.
Overseas investment hurts yen
As Japan continues to navigate economic challenges, the evolving investment strategies of “Mrs. Watanabe” and the broader retail investors will play a pivotal role in shaping the financial landscape and influencing the value of the Japanese currency.
Mrs. Watanabe originally referred to housewives managing household finances by borrowing low-interest yen and investing in high-yield foreign assets in 1990s. Despite a decline in full-time housewives, retail investors, including men and young women, now carry forward this influential legacy.
The government has encouraged retail investors’ investments with policies like the Nippon Individual Savings Account (NISA), which took effect Jan. 1. NISA aims to turn the trillion of yen held in cash by households into investments in stock markets by offering tax exemptions on capital gains.
Cash makes up more than half of household financial assets in Japan, much higher than other countries due to the prolonged deflationary environment. Households held more than $7 trillion in cash and savings at the end of December, a BOJ quarterly survey showed. This conservative approach stems from the stock market collapse after the 1989 bubble burst, leading many to prefer zero-interest deposits over riskier investments.
Now preferences are starting to shift. Morgan Stanley Mitsubishi UFJ Securities noted that an aging society and longevity also call for better returns for Japanese investors. NISA is helping to shift investment preferences from cash to potentially more lucrative options.
Notably, NISA does not restrict investment in domestic stocks or foreign assets. Many Japanese choose to invest in overseas stocks and bonds, which offer better returns. A report by Citibank indicated a steady shift of household savings towards investments, with a significant portion flowing into foreign securities, exacerbating the yen’s weakness.
Interventions not much help
Japanese authorities spent 9.79 trillion yen ($62.2 billion), about 4.5% of the nation’s foreign exchange reserves, intervening in the foreign exchange market to support the yen over the past month.
Kawamura from the Japanese Embassy in China believes the government intervened in the currency market to slow the yen’s rapid depreciation and curb speculation rather than to maintain a specific exchange rate.
Such interventions, similar to those in 2022, might delay the yen’s decline but are unlikely to reverse the trend without the BOJ collaboration, former BOJ board member Kiuchi said.
Right now, the consensus is that yen, at around 155 per dollar, is deeply undervalued. Yue Bamba, head of Active investment at BlackRock’s active investment business in Japan, believes a fair value is likely in the 130-yen-range. Kawamura compared the yen’s movements to a rubber band, suggesting that while it may fall and rebound, the intervention aims to stabilize the market and prevent extreme fluctuations.
Historically, it’s rare for the yen to depreciate by more than 3 yen against the dollar in a week. Previous interventions occurred during similar rapid declines. Western observers question the sustainability of such interventions.
Intervention in the currency markets require tapping Japan's foreign exchange reserves, which were valued at about $1.14 trillion at the end of April, according to the Ministry of Finance, more than 90% of which are held in U.S. Treasuries. Some institutions estimate that Japan has about 40 trillion yen in foreign reserves that can be used to support the yen. At the recent scale of intervention, that would be support for seven or eight actions.
Kawamura pointed out that foreign exchange intervention can be achieved through various means, including short-term currency swaps between the BOJ and Federal Reserve.
Using interest rates to address domestic economic issues and foreign exchange intervention to tackle currency problems is often seen as unsustainable, said Tan from UBS. This involves the “impossible triangle,” where interest rates and exchange rates cannot be controlled simultaneously in a market without capital controls, he said. Without a significant rate hike, shorting yen would still be attractive, Tan said.
For now, the BOJ is still hesitant to raise interest rates. While the central bank may not raise rates immediately, public criticism and the economic impact of a weak yen could influence future policy decisions, said Masamichi Adachi, chief economist for Japan at UBS Securities. He expected little chance of a rate hike at the next BOJ policy meeting in June, but the central bank may announce a decision to reduce the size of its purchases of long-term Japanese government bonds, which would normally lower their prices and push up yields.
All eyes on Fed
In addition to a rate hike, economists believe the yen’s future heavily depends on Federal Reserve policy decisions. One potential turning point for yen would be a Fed rate cut, which would reduce the appeal of carry trades, said Tan from UBS.
Adachi and other experts agree that Japan’s influence on the yen is limited, while expectations on Fed policy matter more. Adachi notes that as long as the Fed maintains its current rates until at least September, the yen will struggle to appreciate significantly. Even a BOJ rate hike in July is expected to have limited impact on the currency, he said.
UBS expects the Fed to cut rates over five times in 2025, while the BOJ might raise rates three times. The expected narrowing of the interest rate differential could boost the yen to 140 to the dollar by the end of 2025, with similar projections from Morgan Stanley Mitsubishi UFJ Securities.
Contact reporter Denise Jia (huijuanjia@caixin.com)
