Negative Factors Haunt Fed's Aggressive Rate Cuts; Yen Bulls May Peak
The Federal Reserve's significant interest rate cut has provided a tailwind for the Japanese yen, but the many negative factors facing the currency seem to outweigh these advantages.
After experiencing the worst week in nearly five months, the yen continued to be under pressure in Tokyo on Tuesday morning.
The cautious attitude of Federal Reserve Chairman Powell towards the pace of easing has raised the question of whether the yield differential will narrow enough to support the yen, even after the Fed lowers the policy rate by 50 basis points.
Meanwhile, Bank of Japan Governor Haruhiko Kuroda does not seem to be in a hurry to raise interest rates again.
So far this quarter, the yen has appreciated 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 short-lived rally, from capital flows to investor positions.
Despite the Bank of Japan ending its negative interest rate policy, the prospects of weak economic growth and an aging population in Japan have been encouraging local fund managers and corporations to invest elsewhere.
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Although the pace of buying foreign bonds has slowed down this year, direct investment has offset this decline, keeping the total outflow at a strong level of 9.42 trillion yen ($66 billion).
This situation is similar to Japan's trade balance.
Deficits have narrowed since peaking in 2022, but have remained below zero for three consecutive years on a seasonally adjusted basis.
Kazushige Kaida, head of foreign exchange sales at State Street Bank & Trust Company's Tokyo branch, said, "The underlying trend is to sell yen.
Many Japanese investors believe that excess returns cannot be obtained domestically in Japan, but can be obtained abroad."
Even after the Bank of Japan began tightening policy, the overall yield curve in Japan remains below the country's inflation rate.
This is in stark contrast to other major economies such as the United States (where real yields are positive), making these markets highly attractive to Japanese capital.
The Fed's massive rate cut on September 18th is also seen as Powell's effort to ensure a soft landing for the U.S. economy, which may limit further declines in U.S. Treasury yields and the appreciation of the yen.
Jun Kato, chief market analyst at Tokyo Shinkawa Asset Management, said: "Due to the negative yield of the yen, it remains vulnerable to selling pressure."
"Considering that the U.S. economy is not in such a sudden slowdown, the trend of a significant narrowing of the real interest rate gap between the U.S. and Japan may stop."
The Bank of Japan kept the benchmark interest rate unchanged at 0.25% last Friday.
Kuroda said that the upward risk to inflation from a weaker yen is easing, giving the central bank room to consider policy.
Doubts about the sustainability of the rally may prompt speculators to reconsider their bullish yen positions, with the yen reaching its highest level since 2021 this month.
Japan's relatively low interest rates compared to other countries mean that unless the yen's gains are sufficient to offset the yield differential, investors' long positions will suffer losses.
Hideki Shibata, senior interest rate and foreign exchange strategist at Tokai Tokyo Intelligence Laboratory Co., said: "Speculators are unlikely to start building more yen long positions from now on."
"The market has already digested a considerable amount of rate cuts by the Fed.
Due to the real interest rate differential between Japan and the U.S., the pressure to buy yen may have already peaked."