If we talk about which country's financial market situation was most eye-catching in the first quarter of this year, then the answer is undoubtedly Japan - just last month, the Nikkei 225 index just broke the 34 year high record; And this week, the Japanese yen also became the focus of global financial media spotlight: it plummeted to a new low in nearly 34 years in the morning!
This scene may somewhat surprise some currency traders: even though the Bank of Japan just ended negative interest rates last week and announced a rate hike for the first time in 17 years, how did the decline of the Japanese yen quickly further amplify after the country's central bank raised interest rates?
Market data shows that the US dollar against the Japanese yen briefly hit a high of 151.97 in the morning, surpassing the 151.95 level that triggered direct foreign exchange intervention by the Bank of Japan in October 2022. This is also the highest level that the currency has not touched since July 1990.
The sharp decline of the Japanese yen has undoubtedly raised the risk of intervention by the Japanese authorities. But now, perhaps a more urgent issue is:
What is causing this sharp decline in Japan's market?
Is it true that only the Japanese yen is facing depreciation risk in the global foreign exchange market?
What does the sudden emergence of a strong US dollar mean in a recognized year of interest rate cuts by the Federal Reserve?
Why did the Japanese yen collapse?
First, let's answer the first question: Why did the yen collapse?
The answer may not be complicated either - that is, market participants suddenly realized one thing after the Bank of Japan's decision this month: ending negative interest rates cannot actually save the yen. On the contrary, the Bank of Japan's interest rate hike, which was originally a bearish sentiment hanging above the USD/JPY exchange rate, can no longer make yen bears feel wary after the real boots have landed!
In fact, a widely accepted view in the market is that although the Bank of Japan launched a series of tightening measures last week, including ending negative interest rates, canceling yield curve control (YCC), and stopping ETF purchases, its future tightening actions will still be gradual and slow. The long-term prospect of monetary easing in the country will not be completely reversed, especially compared to other central banks in economies that are still at their peak interest rates for decades.
This can also be confirmed in the speeches of the so-called "hawkish" officials within the Bank of Japan today.
Bank of Japan's reviewing committee member Naoki Tamura stated on Wednesday that the way monetary policy is managed is crucial for achieving slow and stable policy normalization and ending large-scale monetary easing. But he also pointed out that the loose environment in the financial market may continue, and the risk of rapid interest rate hikes is relatively small. Normalization means restoring the function of interest rates on the economy and achieving a 2% inflation target. After his speech, the yen clearly expanded its decline.
In an industry hawk and dove camp chart, Naoki Tamura is the most hawkish figure among the nine members of the Bank of Japan's board of directors. But without a doubt, his latest speech is not as "eagle" as people imagine.
In Tamura's latest speech, he did not provide a clear indication of the next normalization measures to be taken. According to most Bank of Japan observers, the next rate cut by the central bank will also be at least until October of this year.
This indicates that for most of this year, the yield gap between US treasury bond bonds and Japanese treasury bond is likely to remain as high as 400 basis points for a long time, and the return of "carry trade" may still be considerable. At present, the yield of US two-year treasury bond is about 4.593%, while that of Japanese two-year treasury bond is about 0.191%, which makes dollar denominated assets more attractive, that is, investors borrow cheap yen and exchange it for dollars to invest in assets with higher returns.
Is the sharp decline of the Japanese yen just a typical "microcosm" of the global currency market pattern?
From the current situation, if the yen weakens further in the future, it is likely to trigger intervention actions by the Japanese authorities.
Japanese officials have issued almost daily warnings about speculative behavior in the foreign exchange market regarding the recent fluctuations in the yen. Japanese Finance Minister Toshiichi Suzuki has recently stated that he will closely monitor foreign exchange fluctuations with a high sense of urgency and take bold actions on exchange rate issues if necessary.
"The market is very sensitive to the 152 region," said Rodrigo Catril, strategist at National Bank of Australia. "If we break through this level, recent history suggests that the likelihood of intervention will be much greater."
Many market participants also believe that the area where the Bank of Japan is more likely to take action is the 155 level. Bank of America believes that if the US dollar/yen exchange rate reaches the 152-155 range, intervention risk will increase, while Bloomberg's survey of economists suggests that the exchange rate level that prompted Japan's Ministry of Finance to intervene is expected to be 155.
However, fundamentally speaking, any intervention may ultimately only be a superficial measure rather than a fundamental one. The Bank of Japan intervened directly in the Japanese yen exchange rate twice in September and October 2022. But this did not change an event: the Japanese yen once again fell into the worst currency among G10 currencies last year, and it has remained the same so far this year.
Now, if people look at the world, perhaps a more worrying point is whether the continuously falling yen this year will only be the most typical epitome of the strength pattern of the global currency market?
From the trend of the year, the US dollar index has accumulated a nearly 3% increase in the first two months of the year. This increase is not significant when measured on a monthly basis - it is evident that people have seen a more aggressive rise in the US dollar last year and the year before. However, if we set aside the overall performance of the US dollar index and look at the rise and fall of major non US currencies, it is not difficult to find that the strength of the US dollar so far this year is actually quite dominant.
The following chart covers the annual rise and fall rankings of 35 major currencies worldwide against the US dollar. What many people may not have expected is that only two types of non US currencies - the Kenyan shilling and the Mexican peso - have risen against the US dollar this year. All other non US currencies, except for the Saudi riyal pegged to the US dollar, have experienced a decline.
From this perspective, although many domestic investors have been concerned about the depreciation of the renminbi recently, in fact, the renminbi has remained relatively strong in the overall non US currency market this year - still able to rank in the top ten of the rise and fall charts.
On the contrary, some other Asian currencies seem to be following the footsteps of the Japanese yen. For example, the Korean won and Indonesian rupiah have both fallen to their lowest levels since November last year. In terms of correlation coefficient, the 60 day correlation index between the Korean won and the Japanese yen has reached 0.35, the highest level since May 2023. A value of 1 indicates that these two currencies are moving completely synchronously.
Why will there be a strong US dollar in the year when the Federal Reserve cuts interest rates?
So, in a recognized year of interest rate cuts by the Federal Reserve, why did a strong dollar emerge?
Since the beginning of this year, some assets denominated in US dollars, represented by gold and Bitcoin, can be said to be exporting against the strong US dollar. But it is obvious that within non US currencies, it is difficult to withstand the "strong winds" of the US dollar at present. The reason behind all of this is actually similar to the current weak background of the Japanese yen - the interest rate spread factor is still developing in favor of the US dollar.
In fact, after the Swiss central bank unexpectedly lowered interest rates last week - becoming the first central bank in the G10 to shift towards easing - some sharp investors in the foreign exchange market have already woken up - they have begun to realize that the Federal Reserve may actually be one of the "highest and longest" central banks in the world to maintain peak interest rates.
Let's first take a look at the G10 central bank. Currently, among these ten central banks, only the Reserve Bank of New Zealand (5.5%) has interest rates that are flat or higher than the Federal Reserve (5.25% -5.5%), while others are lower than the Federal Reserve. And the expected magnitude of many central banks lowering interest rates this year is also greater than that of the Federal Reserve, with the most representative change being the Bank of England - the market had always believed that the Bank of England would lower rates later than the Federal Reserve at the beginning of this year (which was also why the pound had led the G10 currency up for a long time), but with hawkish officials of the Bank of England giving up their insistence on further rate hikes last week and turning to doves, the current market's bet on the Bank of England's June rate cut is actually starting to be higher than the Federal Reserve.
How does the Federal Reserve, which ranks among the top hawks among G10 central banks, compare to emerging markets?
Indeed, many central banks in emerging markets still have benchmark interest rates higher than the Federal Reserve, which seems to be unfavorable for the US dollar in terms of interest rate spread factors. But don't forget - the vast majority of central banks that have already entered the cycle of interest rate cuts are emerging market central banks, and many central banks have already cut interest rates by a considerable amount. Their policy shifts are much faster than those of the Federal Reserve.
This brings about a quite serious problem: the Federal Reserve's interest rates are both higher than those of other developed central banks, and the timing of the interest rate reduction cycle is slower than that of many emerging central banks. This also makes the US dollar unbeatable against other G10 currencies and emerging market currencies in most cases.
All of this directly leads to the situation where the US dollar is almost facing a rare opponent in the foreign exchange market in the first quarter of the year when the Federal Reserve cuts interest rates.
Moreover, despite the median expectation of the Federal Reserve's chart released last week still showing three rate cuts within the year, the actual comparison of official voting points is only 10:9- whether it will be three or two rate cuts is still between two options
If the US inflation data continues to show stickiness in the future, and the estimated number of rate cuts by the Federal Reserve this year increases from six at the beginning of the year to three now, and even less in the future, as an investor, you can also guess - will the US dollar continue to rise?