The yen’s travails in an era of geopolitical rivalry

The yen has moved wildly in holiday-thinned market conditions in Japan, falling to a thirty-four-year low of ¥/$ 160.17 on April 29 before correcting to ¥/$ 156.15 owing to rumors of interventions by the Bank of Japan (BOJ). BOJ officials refused to confirm the rumors of intervention but had expressed concerns about the negative economic impacts of the yen’s recent depreciation. Despite intense market speculation about possible intervention causing volatility, unilateral intervention by the BOJ would not be able to reverse the weakness of the yen which has been driven by fundamental factors. The most likely effects of any BOJ intervention would be a temporary correction spurred by short covering in FX markets. The yen has lost about 10 percent against the dollar since the beginning of this year.

The saga illustrates the global ramifications of US interest rates and a strong dollar. Basically, pro-dollar fundamental factors include resilient economic activity and sticky inflation data in the United States keeping interest rates high for long—pushing the expected first rate cut by the Fed to later this year. In this context, statement by Fed Chairman Powell after the Federal Open Market Committee (FOMC) meeting on May 1 will be scrutinized for clues of the Fed’s intentions. This will keep FX markets on tender hooks until then. By contrast, the BOJ has been reluctant to raise rates much, even though it has brought Japan out of the long period of negative interest rates. This was due to the fact that the BOJ has revised downward its estimate for Japan’s GDP growth for fiscal 2024 to 0.8 percent from 1.3 percent in fiscal 2023. It was therefore not willing to tighten monetary policy in response to FX movements. As a consequence, government bond yield differentials in favor of the United States have hovered near 400 basis points—the widest spread since 2000—and the yen has kept weakening.

Moreover, in an unusual reversal of historical relationship, the dollar’s strength has been associated with elevated oil prices, imposing a double whammy on many countries, especially those having to import oil. The firming trends in both the dollar and oil prices are likely to have benefited from heightened geopolitical tension, including military conflicts in Ukraine and the Middle East.

As a consequence, besides the yen most of the world’s currencies have been under pressure from the dollar, which has been on a rising trend, having appreciated by 30 percent over the past decade. The dollar’s strength is also likely to be sustained as many other countries, including the Euro Area, have been looking for opportunities to cut interest rates to support their economic recoveries since their inflation performances have been better than that of the United States. That would help to keep interest rate differentials in favor of the US dollar.

In Asia, the Korean won (-7 percent against the dollar year-to-date) and China’s RMB (-2 percent) have also been burdened by domestic problems. Specifically, Korea has been hurt by elevated oil prices, the unresolved real estate project financing defaults and uncertainties over government policies after the April general elections. Meanwhile, China has a struggling economy trying to cope with an unfolding property crisis and a host of other structural impediments including high debt levels, an aging population, and slowing productivity growth.

Going forward, the dollar strength will be checked only when fundamentals change. Most importantly, this means upcoming US economic data, starting with the April non-farm payrolls report on May 3. Those numbers will be scrutinized to see if the lower-than-expected 1.6 percent GDP growth for the first quarter of 2024 implies a softening of economic activity and inflation rates in the foreseeable future. If so, expectations of Fed easing can be brought forward again.

In addition, signs of policy coordination among G20 countries could help prevent disorderly fluctuations in foreign exchange markets. In this context, the G20 and the International Monetary and Financial Committee (IMFC) might have missed a good opportunity during the IMF-World Bank Spring Meetings two weeks ago to show that they can rise to the occasion to reassure financial markets. Realistically, the G20 may not be able to reach any agreement on policy coordination given the increase in the level of mutual distrust among members as a result of geopolitical rivalry. If the G20’s inability to cooperate persists, leaving many countries in the world struggling to cope with the dollar’s strength on their own, that will be adding to the growing economic costs of geopolitical rivalry.