The Yen’s Lament: Why Intervention Won’t Stem the Tide

The recent intervention by the US and Japan has been hailed as a historic measure to halt the yen’s slide, but it appears to have fallen short of its lofty goals. The yen continues to trade at multi-decade lows, with a current exchange rate of over 159 per dollar. This is hardly surprising, given the yawning gap in returns between Japan and the US.

The classic carry trade remains alive and well, as investors borrow cheaply in yen and invest in higher-yielding assets. Japanese borrowing costs are still significantly lower than those in the US, incentivizing investors to seek out better returns abroad. Jesper Koll, expert director at Monex Group, notes that intervention has scared markets but not stopped the laws of finance: “Money flows in the direction of maximum returns.”

The Bank of Japan (BOJ) has been reluctant to tighten policy, with some speculating that concerns about the banking system or Japan’s massive public debt burden may be constraining policymakers. This reluctance will likely have far-reaching implications for the yen’s value.

The BOJ’s Dilemma

The BOJ’s next monetary policy meeting in September will be a crucial moment of truth. Can the BOJ find a way to tighten policy without crippling Japan’s economy, or will it continue to dither in the face of a rapidly weakening currency? Koll notes that “the bigger shock for investors was not intervention itself but the BOJ’s reluctance to tighten policy more aggressively.”

Crédit Agricole CIB has offered an intriguing insight into Japan’s economic woes. According to their analysis, the deeper problem lies in an asymmetry of investment power between the two economies. While the US continues to invest heavily in cutting-edge technologies like artificial intelligence, Japan’s efforts to promote public-private investment have yet to bear fruit.

This asymmetry has significant implications for the yen’s value. As long as Japanese assets remain unattractive compared to their overseas counterparts, investors will continue to send money abroad in search of better returns. Intervention may serve as a temporary guardrail against the yen’s acceleration, but it is unlikely to stem the tide of capital outflows.

A Sustainable Yen Recovery?

For a sustainable recovery to occur, Japan must address its own economic fundamentals. This means investing in domestic industries, promoting innovation, and making Japanese assets more attractive to investors. As State Street’s Loo notes, “Ultimately, though, intervention can buy time, but the heavy lifting will fall on BOJ normalization as early as September.”

The US and Japan have sought to strengthen their deterrent by highlighting the Federal Reserve’s foreign and international monetary authorities’ repo facility. While this may make it more expensive for investors to bet against the yen, it is unlikely to alter the underlying dynamics driving the currency’s decline.

The BOJ’s next move will be crucial in determining the future course of the yen. Japan must take concrete steps to make its assets more attractive to investors if it hopes to achieve a sustainable recovery.