Adverse factors "entangled", the Federal Reserve's significant interest rate cut may not change the yen bulls' potential "peak" trend

According to the Zhitong Finance and Economics APP, the significant rate cut by the Federal Reserve has brought tailwinds to the Japanese yen, but the yen is facing many negative factors that seem to outweigh these advantages. After experiencing its worst week in nearly five months, the yen continued to be under pressure on Tuesday morning in Tokyo.

Federal Reserve Chairman Powell's cautious approach to easing has raised a question: even after the Fed cut interest rates by 50 basis points, will the yield differentials narrow enough to support the yen? Meanwhile, Bank of Japan Governor Kuroda does not seem eager to raise rates again.

So far this quarter, the yen has appreciated by 12% against the US dollar, making it the best performer among the 17 currencies tracked by Bloomberg. However, investors can easily find reasons for a rebound or a temporary setback from various aspects such as capital flows and investor positions.

These four charts illustrate the reasons:

Despite the Bank of Japan ending its negative interest rate policy, the sluggish economic growth and aging population outlook have been encouraging local fund managers and companies to invest elsewhere. While the pace of buying foreign bonds has slowed down this year, direct investments have offset this decline, keeping the total outflow at a strong level of 9.42 trillion yen (66 billion US dollars).

This situation is similar to Japan's trade balance. The deficit has been reduced since reaching its peak in 2022, but after seasonal adjustments, it has remained negative for three consecutive years.

Kazushige Kaida, Head of Foreign Exchange Sales at State Street Bank & Trust Company's Tokyo branch, said, "The potential trend is to sell the yen. Many Japanese investors believe that excess returns cannot be obtained domestically in Japan, but can be obtained overseas."

Even after the Bank of Japan began tightening its policy, the overall yield curve in Japan remains below the country's inflation rate. This is in stark contrast to other major economies like the United States (where the real yield is positive), making these markets highly attractive for Japanese funds The Federal Reserve's large rate cut on September 18th is also seen as Powell's efforts to ensure a soft landing for the U.S. economy, which may limit further decline in U.S. bond yields and the appreciation of the yen.

Jun Kato, chief market analyst at Tokyo Shinkin Asset Management, said, "As the yield on the yen is negative, the yen is still vulnerable to selling pressure." "Considering that the U.S. economy is not in such a sudden deceleration state, the trend of significantly narrowing the real interest rate differential between the U.S. and Japan may stop."

The Bank of Japan kept its benchmark interest rate unchanged at 0.25% last Friday. Kazuo Ueda said that the softening yen is easing the upward risks to inflation, giving the central bank room to consider its policies.

Doubts about the sustainability of the uptrend may prompt speculators to reconsider their bullish yen positions, as the yen reached its highest level since 2021 this month. Japan's low interest rates relative to other countries mean that investors with long positions in the yen will incur losses unless the yen's appreciation is sufficient to offset the yield differential.

Hideki Shibata, senior interest rate and foreign exchange strategist at Tokai Tokyo Intelligence Laboratory Co., said, "Speculators are unlikely to build more yen long positions from now on." "The market has already digested a considerable amount of the Fed's rate cuts. Due to the real interest rate differential between the U.S. and Japan, the pressure to buy yen may have peaked."