Column: Constraints to future dollar depreciation and yen appreciation, the internal and external environment around the yen differs from 1998 = Minoru Uchida | Reuters

(Reuters) – Faced with a sharp fall in the dollar/yen exchange rate, some fear a repeat of the dollar/yen plunge seen between 1998 and 1998.

On November 16, 2008, faced with a sharp drop in the dollar/yen exchange rate, some voiced concerns about a repeat of the dollar/yen depreciation seen between 1998 and 1998 (= sharp rise in the Yen). This picture is taken in front of a currency exchange table in Tokyo on October 21, 2022. REUTERS/Issei Kato

At that time, the dollar/yen exchange rate climbed to 147.64 yen in August of the same year while resisting foreign exchange intervention to buy the Yen.

The Russian currency crisis and the bankruptcy of major US hedge fund LTCM led to a large-scale unwinding of yen carry trades.

However, compared to those days, the position in which the yen is placed is very different. Looking forward to the future dollar / yen exchange rate, we will break down the position in the dollar and yen below.

First, the strength of the dollar may have peaked. This is due to signs of a change in the US stance on a strong dollar rather than a ceiling on interest rate rises, or the final rate (the final destination), which has fallen from the traditional view.

In past columns, I have noted that destructive dollar appreciation is likely to continue. This is because the dollar combines the elements of a high interest rate currency, a resource rich currency, and a reserve currency, and the authorities have shown a willingness to tolerate a strong dollar.

In fact, the dollar, as measured by the real effective exchange rate, reached the second highest level after 1985, when the Plaza Accord was signed. This cannot be explained by movements in interest rates alone.

On the other hand, in my previous column, I noted that if the devaluation of the currencies of emerging countries leads to instability in the market, the United States may intervene in coordinated dollar selling. In recent years, the United States has tended to pay more attention to the international situation in its monetary policy decisions, as well as domestic factors such as price stability and maximizing employment. Given this point, the possibility that the US stance would change was not zero, even though it was consistent with reining in inflation.

In fact, US Treasury Secretary Janet Yellen told reporters at the G20 summit on the 13th that she was worried about the effects of the strong dollar on the devaluation of other countries’ currencies. He also said he was very concerned about the debt of low income countries.

This observation suggests the possibility that all countries share a strong sense of crisis regarding further appreciation of the dollar. In particular, stopping the appreciation of the dollar would be welcomed by developed countries, including Japan, and it would not be difficult to reach a consensus.

However, there is no changing the fact that controlling inflation remains the most important issue for the United States. Interest rates are expected to continue to be raised, even when taking into account trends in emerging countries. For now, the spread of external interest rates will remain wide, and the outcome of primary inflation remains unpredictable.

Considering the above points, it is hard to imagine that the dollar will weaken even if the appreciation of the dollar is stopped. It is very likely that the stock will gradually regain its strength.

Next, let us look back at the situation in 1998, when the Yen rose, in terms of the outlook for the yen exchange rate. At that time, the yen carry trade was rampant as the interest rate differential between Japan and the United States widened. It was also during this period that Japanese banks, busy getting rid of bad loans after the bubble economy burst, were required to pay extra costs (the so-called Japanese premium) when raising money in the market.

Therefore, it is very likely that the depreciation of the yen at the time was also influenced by expectations of a weaker yen associated with “selling Japan.”

On the other hand, it is worth noting that when the Yen rallied after August 1998, speculators’ yen shorts were written off and they turned to yen longs. On the other hand, 1998 was also a time when public money was injected into large banks and some regional banks, and expectations emerged for progress in the disposal of non-performing loans and financial restructuring.

The Bank of Japan also lowered its non-collateralized overnight call rate target to around 0.25% in September of the same year. In addition, with the possibility of an additional injection of public funds, the elimination of the Japanese premium was becoming a prospect.

In addition, exports were expanding at the time, benefiting from the depreciation of the yen, and expectations for an improvement in business confidence were emerging. Against this background, foreign investors moved to correct their Japanese stocks under pressure, and in the year from October 1998, they bought about 10 trillion yen in Japanese stocks. Some of this is believed to have included buying Yen without currency hedging.

In addition, Japan’s trade surplus at the time reached about 30 trillion yen during the two years 1998 and 1999. It is possible that buying Yen according to actual demand contributed to the depreciation of the dollar/yen pair.

In this way, behind the rapid rise of the yen at the time, as well as the elimination of speculative yen shorts, the inward investment of securities and the purchase of Yen that matches Japan’s trade surplus must have had an effect. It is believed that speculators have turned from selling the yen to actively buying the yen.

On the other hand, even if the yen short is eliminated as it is, there is no reason to buy the yen from there. In light of persistently high resource prices and slow growth in exports in terms of volume, a high level of trade deficit is expected to persist.

Furthermore, looking at the interest rate difference between Japan and the US, it will be difficult to build positions such as dollar short/yen long, which will lead to negative carry returns.

Overall, there is little material for the Yen to continue to rebound independently. If I had to cite a factor for the Yen to rise independently and significantly, it would be time for the BOJ to move from another level of monetary easing. That said, if the view that peak US inflation, which drove the recent appreciation of the Yen, remains entrenched, there is little need for the BOJ to review its unconventional monetary easing in the first place.

In light of the above, the dollar/yen pair is likely to regain its strength and return to the low-140 yen range once again, although the pair will remain concerned on the downside for the time being. If US inflation peaks more clearly, it is true that the US dollar will continue to decline, but in that case, the market is likely to turn to risk appetite. The depreciation of the Yen, which outweighs the depreciation of the dollar, is likely to prevent the dollar/yen exchange rate from depreciating.

On the other hand, the upside of the dollar/yen pair is likely to go heavy for the time being. The deviation from the purchasing power parity published by the International Monetary Fund (IMF) (96.53 yen at the end of last year) has reached an all-time high, and in a value judgment, the dollar / yen can be evaluated as a dog cuff significantly. For that reason alone, a strong contrast between a weak yen and a strong dollar is needed for the dollar/yen pair to rise above 140 yen again.

In that regard, it seems necessary to wait for the prospects that the final rate will be more than 5% to emerge once again before the dollar rises again. Until the US Federal Open Market Committee (FOMC) meets in December, the dollar / yen pair is likely to be influenced by data such as economic indicators and comments from high-ranking officials. As the saying goes, “rest is also worth the price”, it will be time to assess the situation for a while.

Editing: Kazuhiko Tamaki

(This column was posted on the Reuters Forex Forum. It is written based on the author’s personal opinion.)

*Mr. Minoru Uchida is an associate professor at the Faculty of Commerce, Takachiho University and an ALCOLAB foreign exchange analyst. After graduating from Keio University, he joined the Bank of Tokyo (currently Mitsubishi Bank UFJ). Former Chief Analyst of Forex Market Operations from 2012 to 2022. Incumbent since April 2010. In J-money magazine’s Tokyo foreign exchange market survey, he came first in individual rankings for 9 consecutive years since 2013. Certified international investment analyst, member of editorial board of Securities Analyst Journal, visiting researcher at the Institute of International Monetary Affairs, Master of Economics (Kyoto Sangyo University).

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