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Don’t Bet on the Japanese Yen Rebound Just Yet

  • While the yen has rebounded somewhat in recent weeks, helped in no small measure by the Bank of Japan pledging to pick up the slack, the slide may be far from over.
  • Pressure has eased on the yen, with growing concerns over a recession in the U.S. but it’s less clear how long this will last.

Japan’s “lost decades” were marred by low productivity, growth and inflation, a period of economic stagnation and politicians are eager to avoid a repeat of those painful years.

With the Japanese yen having been hammered of late because of the U.S. Federal Reserve tightening policy, a move increasingly divergent from the Bank of Japan which has doubled down on keeping conditions, loose, the yen went into virtual freefall against the dollar.

And while the yen has rebounded somewhat in recent weeks, helped in no small measure by the Bank of Japan pledging to pick up the slack, the slide may be far from over.

After Japan’s economic bubble burst in 1990, the country became locked into a vicious cycle of stagnation – slow growth and slow or falling prices, leading to a persistent lack of demand.

Put simply, if consumers expect prices will continue to fall, there is no urgency to consume today.

And while a falling yen and soaring oil prices have pushed headline Japanese inflation to 2.5%, Tokyo appears to have plenty of appetite for more, because underlying inflation, excluding volatile food and fuel prices, is still weak.

Significantly, there has been no translation of higher prices to higher wages.

The Bank of Japan has also been so far successful in its yield curve control, significantly increasing bond purchases to enforce a cap on benchmark 10-year yields at close to zero, when hedge funds piled up short positions.

Pressure has eased on the yen, with growing concerns over a recession in the U.S. but it’s less clear how long this will last.

The Bank of Japan is undergoing regime change at the moment, with board member Guoshi Kataoka, a outspoken dove who believes in reflating Japan’s economy, replaced by the far more hawkish Hajime Takata who has long expressed skepticism about the feasibility of the central bank’s 2% inflation target and has been vocal about the negative side effects of easing.

Takata’s term expires next April and what matters is Japanese Prime Minister Fumio Kishida’s selection for a successor, which will shape a more long-term path for not just the Japanese economy, but the yen as well.

U.S. labor markets appear resilient and the Fed remains in denial about recession, meaning that the yen is likely to remain volatile for now, but has somehow survived the first round.

It’s less clear if the Bank of Japan can continue to weather the onslaught of multiple attacks on its attempts at yield curve control from well-oiled hedge funds which are lurking to bet that the yen can’t hold.

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