The plight of non-US currencies behind the depreciation of the Japanese Yen

Key Points:

The recent decline in the Japanese yen has weakened the interest rate logic, and this round of yen depreciation may be related to Japanese investors' overseas asset allocation activities. The speculative short-selling sentiment of overseas investors towards the yen, rising import prices, etc., have also put pressure on the yen. Although the Bank of Japan previously introduced market support measures, the marginal effect of unilateral exchange rate intervention is gradually diminishing. The main driving factor for the medium-term correction of the yen is still the US-Japan interest rate differential, especially US economic data and the Fed's direction.

The depreciation of the yen is not an isolated case, but rather a collective dilemma of a strong US dollar and non-US currencies. Under a strong US dollar, it is difficult for the domestic economic environment to determine the trend of the domestic currency. The marginal operation of monetary policy is also difficult to reverse the exchange rate trend. Despite also depreciating, the renminbi is relatively strong compared to other non-US currencies in this round; if the US dollar falls later, the appreciation space of the renminbi will also be compressed.

Events:

On July 2nd, the yen exchange rate plummeted, with the yen against the US dollar hitting a new low in 38 years, falling to 161.75 at one point, and the year-to-date depreciation of the yen against the US dollar expanded to 14.8%.

Main Content

1. Rate Hikes and Market Support, Unable to Halt the Trend of Yen Depreciation

The interest rate logic behind the recent decline in the yen has weakened. From 2022 to 2023, the main factor driving the trend of yen depreciation is the US-Japan interest rate differential, especially US economic data and the Fed's direction. The yen has basically followed the basic logic of "short-term looking at the Fed, medium-term looking at the Bank of Japan". However, since May 2024, the depreciation trend of the yen has deviated from the US-Japan interest rate differential. Despite the gradual convergence of the US-Japan interest rate differential under the background of fluctuating US bonds and stable Japanese bonds, the yen's depreciation trend has not been reversed.

The current yen depreciation may be related to Japanese investors' overseas asset allocation activities. The correlation between the yen and US stocks has significantly increased since the first quarter of 2024. In January 2024, the government initiated a reform of the Japanese individual tax-exempt savings account (NISA) plan, enhancing the attractiveness of retail investors to the market. NISA significantly expanded the annual investment limit, with the small investment limit increasing from 400,000 yen per year to 1.2 million yen, and the growth account annual investment limit increasing from 1.2 million yen per year to 2.4 million yen, while lowering the account deposit threshold to promote Japanese household investment. The expansion of NISA accounts has boosted Japanese investors' preference for overseas assets. According to Nikkei data, the inflow of funds into foreign equity investment funds through NISA accounts reached a new high in June, and the allocation of Japanese residents to overseas assets continues to rise. Looking at Japan's international investment position data, the equity securities investment sub-item in Japan's external assets has been steadily increasing since the end of 2023. The demand for US dollar assets by investors may be an important factor in the recent softening of the yen.

Speculative short selling sentiment among overseas investors towards the Japanese Yen remains high. In the depreciation trend of the Japanese Yen that started in the second half of 2021, financial institutions' speculative short selling has played a role in exacerbating the situation, with short selling sentiment rising even further after breaking key levels multiple times. According to data from the U.S. Commodity Futures Trading Commission (CFTC), speculative short positions on the Yen in the U.S. market reached 174,000 contracts in the last week of June, hitting a new high in short positions since data has been available in 2008. There is currently no evidence in the market that expectations for the Yen have bottomed out.

Demand for the U.S. Dollar remains high among Japanese import companies. Since 2023, as domestic demand in Japan has been recovering, import demand has remained high. Despite the Yen depreciation driving high export growth, trade has consistently maintained a deficit. Since 2024, with import prices rebounding and returning to positive growth territory, Japan's trade deficit continues to expand. The demand for U.S. Dollars by importers is also one of the pressures contributing to the depreciation.

The marginal effect of unilateral exchange rate intervention is gradually diminishing. Japan's exchange rate intervention can only slow down the rate of decline and is difficult to become a decisive factor in reversing the trend. At the end of April and beginning of May, when the exchange rate approached 160 for the first time, the Ministry of Finance conducted at least two exchange rate intervention operations, totaling around 98 trillion Yen (620 billion U.S. Dollars). However, the effectiveness of the intervention is gradually decreasing. In early July, the Yen once again broke through 160, and the market expects that a new round of intervention may be triggered around 165. Japan's reliance on foreign exchange intervention is increasing, but as key levels continue to be breached, market confidence in intervention is gradually decreasing, and speculative trading remains unabated.

The main driving factor behind the medium-term correction of the Yen is still the U.S.-Japan interest rate differential, especially U.S. economic data and Federal Reserve actions. If the Fed cuts interest rates in September, it could be a turning point for the Yen. Overall, Japanese authorities have a relatively high tolerance for Yen depreciation, but they have recently become more concerned about the negative impact of depreciation, believing that excessive depreciation has more drawbacks than benefits for the economy. Previously, the Governor of the Bank of Japan expressed concerns about the impact of exchange rates on inflation, implying that if further depreciation occurs, an early rate hike may be considered. Slowing down Yen depreciation may become the main topic of the Bank of Japan's monetary policy meeting in July.

II. The depreciation of the Yen is not an isolated case, but a collective dilemma driven by a strong U.S. Dollar and non-U.S. currencies

Under the combination of high interest rates and a strong U.S. Dollar, non-U.S. currencies collectively face pressure to depreciate. The U.S. Dollar index briefly fell in 2024 but overall remains strong, driven by factors including: (1) The European Central Bank, Bank of Canada, Swiss National Bank, etc., have all started cutting interest rates, while the Federal Reserve's actions are more gradual. (2) In the first quarter of this year, although the U.S. GDP annualized growth rate slowed significantly, domestic end demand remained relatively robust, while the economic performance of Europe and Japan was relatively mediocre, with no clear signs of a reversal in the strong U.S. and weak Eurozone trend. (3) The Russia-Ukraine conflict remains unresolved, the situation in the Middle East has deteriorated significantly, and the U.S. Dollar continues to serve as a safe haven asset (4) The marginal improvement in Trump's election prospects is favorable for the USD due to his policies such as tax cuts and tariffs. Under a strong USD, not only the JPY but also other developed and emerging market currencies have shown significant weakness, with exchange rate pressure becoming a common challenge, causing certain disturbances in the stock and bond markets.

Referring to previous experiences and the recent trend of the JPY, there are the following patterns worth considering in the exchange rates of non-USD currencies:

First, under a strong USD, it is difficult for the domestic economic environment to determine the trend of the country's currency. Even with a strong domestic economy, it will still face challenges from exchange rates under a strong USD. For example, despite India's strong economic performance in recent years, with GDP growth and manufacturing sector sentiment relatively higher than the U.S., the Indian Rupee still struggles to avoid depreciation.

Second, the marginal operations of monetary policy make it difficult to reverse the trend of exchange rates. The recent actions of the Bank of Japan are a typical example. Despite conducting tightening and rate hike operations at the end of last year and in the first quarter of this year, the market finds it hard to form long-term expectations of continuous rate hikes, lacking confidence in the economic outlook of Japan, leading to a significant depreciation of the JPY.

III. Although depreciating, the RMB is relatively strong compared to other non-USD currencies in this round; if the USD falls later, the appreciation space of the RMB will also be compressed

The RMB against the USD is once again facing depreciation pressure in 2024, dropping from around 7.1 at the beginning of the year to below 7.25 currently, close to the low point in the third quarter of last year. The core factor remains the overall depreciation trend of non-USD currencies under a strong USD, in addition, the middle of the year is generally a period of seasonal weakness for the RMB. However, considering the trend relative to other currencies, the depreciation of the RMB against the USD is actually relatively low, with a smaller fluctuation range. In the first half of this year, the average depreciation of major global currencies against the USD was around 4.7%, but the RMB only depreciated by 2.4%. With the strengthening expectation of a rate cut by the Federal Reserve, the limited further rise in the USD index, if the global economy marginally improves under the support of rate cuts, the USD index may gradually decline, releasing pressure on the RMB exchange rate, which will be positive for domestic monetary policy and stock market sentiment. However, due to its relative strength in the previous period, the appreciation space may also be limited at that time.

Risk Warning: Unexpectedly high U.S. inflation, unexpectedly strong U.S. economic growth leading to further tightening of the Federal Reserve's monetary policy, a sharp appreciation of the USD, an increase in U.S. bond yields, continued decline in U.S. stocks, commercial bank bankruptcy crisis, and emerging markets facing currency and debt crises. Unexpectedly severe U.S. economic recession leading to a liquidity crisis in financial markets, forcing the Fed to shift to easing. Unexpectedly severe European energy crisis, deep recession in the Eurozone, global markets in turmoil, shrinking external demand, policy facing dilemmas. Escalation of global geopolitical risks, deterioration of U.S.-China relations beyond expectations, uncontrollable factors in bulk commodities and shipping, deepening of deglobalization, continuous disruption of supply chains, worsening competition for related resources