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USD/JPY Rally Driven by Global Macro Fundamentals, Not BoJ Hawkishness

By Alfonso PeccatielloCurrenciesDec 08, 2023 05:23AM ET
www.investing.com/analysis/usdjpy-rally-driven-by-global-macro-fundamentals-not-boj-hawkishness-200644250
USD/JPY Rally Driven by Global Macro Fundamentals, Not BoJ Hawkishness
By Alfonso Peccatiello   |  Dec 08, 2023 05:23AM ET
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As macro investors, we are often inundated with flashy headlines, and recently Japan has been front and center.

Yet with all this noise, it’s easy to miss the forest for the trees.

That’s why in this piece we will:

  • Explain what really drove the recent moves in JPY;

  • Discuss the real underlying macro trends in Japan;

  • Assess what the BoJ is likely to do next;

  • Cover the implications for global bond markets and the Yen.

The outsized moves in JPY and Japanese bond markets have been catching headlines recently - the common narrative is that Japan is finally there to unwind its super-easy monetary policy and that pushes yields higher and the Yen stronger.

Evidence says the move in JPY has more to do with something else.

USD/JPY Chart
USD/JPY Chart

The chart above shows the very tight relationship between 10-year US vs Japan yield differentials (blue, LHS) and USD/JPY (orange, RHS): if yield differentials shrink rapidly, the Yen gets a boost.

It's really simple and intuitive FX pricing theory: wide yield differentials and low volatility will make people interested in borrowing JPY and buying USD, and when yield differentials narrow like today this ''carry trade'' will unwind and the JPY strengthens.

Why are yield differentials narrowing? Because of the BoJ?

Not really.

Bonds have been catching a bid globally since October: the rapid decline in the blue line from 350 bps to 270 bps is almost exclusively due to Treasuries (not Japanese bonds).

And now mind the gap in the red circle.

At this level of yield differentials, USD/JPY should already be at 140.

Back in July, the 10y yield differential between Japan and the US was 280 bps and USD/JPY was 138.

Today it's 270 bps (lower!) and USD/JPY is 144 (higher!) yet people seem to find the JPY move out of whack.

USD/JPY vs Oil Prices
USD/JPY vs Oil Prices

The other important global macro driver of JPY price action has been crude oil.

Japan is a net importer of crude oil, and the US is a net exporter: guess what happens to USD/JPY when the price of oil goes down rapidly?

USD/JPY goes down: the Yen appreciates because the terms of trade for Japan become more favorable.

In other words: the Yen is adjusting to international macro fundamentals, not reacting to Japanese macro or an immediate risk of a BoJ hawkish shift.

Japan Services PMI
Japan Services PMI

Japanese services inflation (orange) was running at 3% in May but it’s now back below 2%, and nominal wages (blue) are growing at only 1.4%.

If Ueda and the BoJ wanted to react to immediate price pressures, April/May was the moment to do so - the situation is much less urgent today.

Imagine this.

After 20+ years of ZIRP and QE the Bank of Japan tightens policy now, but global inflationary pressures continue to subsidize.

The Yen strengthens rapidly, and it kills any hope for Japanese inflation and wages to actually settle at 2%.

The deflationary mindset kicks in again, and Ueda doesn’t look great.

Ok, quick recap:

  • Services inflation and wage growth in Japan don’t justify a BoJ hawkish shift;

  • Yet the JPY has been rallying rapidly: that’s a function of two things;

  • A global bond rally which compressed yield differentials;

  • Oil prices collapsing which helps Japan as a net importer of crude;

The last piece of the puzzle to assemble here is the impact these crucial Japanese developments might have on global bond markets.

Japan is a massive exporter of capital: Japanese investors own trillions of dollars of foreign assets and they are big in Treasury markets.

What are they doing there?

Japan 10-Year Treasury Yield
Japan 10-Year Treasury Yield

Japanese investors have been absent from Treasury markets since late 2021 and actively selling a ton of bonds in 2022.

They are now back at buying Treasuries - what drives them?

Japanese investors involved in buying foreign bonds will also face FX risks.

To buy Treasuries they need to convert JPY into USD, buy the bonds, and at some stage revert back the FX transaction.

This means USD/JPY will largely affect the P&L of their bond transaction.

This is why they generally look at Treasury yields in a different way: the orange line shows 10-year Treasury yields in the eyes of a Japanese investor which also hedges USD/JPY risk for 12 months to cover that FX risk for a reasonable time.

You can see the relatively tight correlation between the attractiveness of FX-hedged Treasuries (orange line up = more attractive) and the actual net buying flows in foreign bonds from Japanese investors (blue line up = they buy more).

In 2022 Treasury yields went rapidly up but Japanese investors were on strike because the USD/JPY FX hedging costs were prohibitive.

Things are a bit better today, and Japanese investors are already back at buying.

The Fed drives these USD/JPY hedging costs more than the BoJ, and once again it’s global macro drivers that matter more than some flashy headlines about Japan itself.

Get US growth and inflation right, get macro right.

Don’t miss the forest for the trees.

USD/JPY Rally Driven by Global Macro Fundamentals, Not BoJ Hawkishness
 

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USD/JPY Rally Driven by Global Macro Fundamentals, Not BoJ Hawkishness

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Comments (5)
Zehra Zain
Zehra Zain Dec 11, 2023 1:02AM ET
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Excellent outlook on things and this looks quite helpful for future
Xavier Valente
Xavier Valente Dec 10, 2023 6:22AM ET
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It was BoJ mainly
Mehraj Din
Mehraj Din Dec 08, 2023 12:28PM ET
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excellent summary for current events unfolding at macro level thanks
jurken damste
jurken damste Dec 08, 2023 12:07PM ET
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excellent analysis
Maria Ariam
MariaAriam Dec 08, 2023 12:04PM ET
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pls stop bs-ing informed people ..the yen price action is driven by 2 forces: a. BOJ that is desperately intervening in this market so that the 30 trillion $ carry trade don;t fall in their head and b. very serious trouble brewing there in Japan related to the expected bankruptcy of SoftBank (that will trigger strong selloffs in all stocks, starting with the ones owned by them: ARM, BABA and all the other ones).  Also there's the risk of usd/jpy carrytrade unwinding that will kill all bozos that got long US stock markets and US bonds financing themselves from Japan (yen).
Maria Ariam
MariaAriam Dec 08, 2023 12:04PM ET
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we are on the verge of a bear markt AS STRONG AS IN 2008-2009 (3rd wave to the downside). The so-called Market Masters in US stocks can keep underwater VIX and pump stocks as long as they want. When it will blow the situation, IT WILL BLOW, no matter what Masters are doing. After the explosion FED WIL START CUT RATES! AFTER! NOT BEFORE -20% OR MORE in Us stock markets! Without a strong red crisis... why would FED cut? WHY ?  All the present US stocks markets bullishness is with thin volume based only on stupid retailers and on bears sacrificed (shorts covering). NOT A TRUE BULL RUN, NO MATTER WHAT PRICE! Check indicators and volumes, NOT PRICE!
Maria Ariam
MariaAriam Dec 08, 2023 12:04PM ET
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only bozos keep on hunting price action. The witty man looks ALSO at tech indicators, volumes, intermarket analysis, so on and so forth
Maria Ariam
MariaAriam Dec 08, 2023 12:04PM ET
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and not only softbank is the problem - also other shell banks might experience problems soon ... starting with UBS and continuing with Lloyds, HSBC, some banks in China (as evergrande will be liquidated in 2024) and after that all the others sectors. When I'm saying we are near a creeping bear market I might know what I'm saying. Will the central bank intervene AFTER THE BEARISH BLOW DOWN (MIN -20% LOWER). Yes, they will. More QE? Yes they will. Interest lower or near 0? Why not ? BUT ONLY, O N L Y !!!, AFTER A BREAKDOWN OF MAYHEM PROPORTION.  Not now, not in March 2024 or whatever dummy bears are saying like some stupid bozos getting long at the top!
 
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