Yen Plummets as Japan Abandons Further Rate Hikes, Carry Trade Returns with a Vengeance

Japan's Schizophrenic Approach to Currency

Over the past two months, the yen carry trade has been the subject of much exaggeration, mainly due to Japan's inconsistent approach to its currency. For many years, the Bank of Japan (BOJ) and the government worked tirelessly to devalue the Japanese currency in an attempt to ignite inflationary wage growth. This seemed to be the only way out for a country trapped in a deflationary debt crisis. However, when the yen plummeted to a 40-year low earlier this year, Japan quickly reversed its strategy, intervening in the open market multiple times to prevent further selling of the currency. This was due to the resulting inflation leading to a decline in living standards and causing public outrage over runaway inflation, which eventually led to the downfall of the Kishida government.

Effects on Japan's Standard of Living

With real wages collapsing, Japan's standard of living has deteriorated significantly. Meanwhile, the BOJ is denying the existence of inflation and has sparked what could be the last Japanese stock bubble. In July, the BOJ surprised the market with a second rate hike, even as the rest of the world was aggressively cutting rates. This caused the yen to surge, and the yen carry trade was reportedly left for dead. The plunge in the USDJPY was historic: falling from 162 to 140, numerous yen shorts were wiped out.

Consequences of the Rate Hike

The rate hike not only caused the Nikkei to plummet, forcing the BOJ to immediately defend the "wealth effect", i.e., stocks, but it also meant that Japan was about to revert back to its status quo of crippling deflation. This is because Japan, unlike the US and due to its 400% debt/GDP, is unable to find a happy medium and always swings from one extreme to the other. A recent drop in a core CPI measure for Japan suggested that the surging yen was about to trigger a new deflationary wave.

Japan's Hiking Cycle Comes to an End

This morning, Japan’s new Prime Minister Shigeru Ishiba, who was seen as an uber hawk and the leader that would force the BOJ to continue hiking for the foreseeable future, confirmed what we have been saying for the past two months. He announced that the economy isn’t ready yet for further interest rate hikes, following a meeting with Bank of Japan Governor Kazuo Ueda. This statement jolted the yen to its weakest against the dollar for the day, and has sparked the USDJPY's next move back to 160.

BOJ's Commitment to Raising Interest Rates

At the meeting between Ishiba and Ueda, the central bank chief qualified his commitment to raising interest rates if the economy and prices match the BOJ’s forecasts. He said, “While we will adjust the degree of monetary easing if the economy and prices match our forecasts and the economy works as we expect, I also told him we want to look carefully to see if that really is the case because we have sufficient time to do so.”

Central Bank Independence

This statement is interesting because it makes it clear that when it comes to financial repression and monetary policy, "western" central banks are anything but independent and always do the bidding of their sovereign masters. This is particularly amusing considering the western media is abuzz with concerns over what could happen to Fed "independence" in the US should Trump win. Well, spoiler alert: central banks have never been independent, and the latest yen interlude just confirmed it!

Return of the Yen Carry Trade

With the BOJ hiking cycle coming to an end, the yen is now free to resume its decline, and that means the yen carry trade is back in full swing. This was confirmed by one of Goldman's best FX traders, Kerem Cirpan, who wrote yesterday, "Nature is healing for JPY carry trades on the back of the Fed easing into strong growth and BoJ showing no interest for rapid policy normalization."

Bottom Line

The yen's rollercoaster ride over the past few months has been a testament to the complexities and unpredictability of global financial markets. As Japan abandons further rate hikes and the yen carry trade returns with a vengeance, it will be interesting to see how these developments impact the global economy. What are your thoughts on this? Share this article with your friends and let us know your views. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.