The JPY is trading at a 20-year low of 126 against the USD. The dovish Bank of Japan is capping 10Y Japanese Government Bond (JGB) yields ‘around 0%’ - as the first chart shows - to push inflation up to its 2% target while the Federal Reserve is ready for 50bps hikes to curb inflation.
Source: Bank of Singapore, Bloomberg.
If the JPY keeps weakening, the BoJ - on behalf of the Ministry of Finance - could intervene to support the currency by drawing down its foreign exchange reserves. But the last time Tokyo acted to defend the JPY by selling USDs was in 1998 when the currency fell into a 130-140 range before finally hitting a low of 148 as the second chart shows. We think officials will only intervene now in the currency markets if the JPY plunges into a 130-140 range again versus the USD.
Source: Bank of Singapore, Bloomberg.
Instead, the larger risk to JPY bears would be if the BoJ suddenly lifts its JGB target, enabling 10Y yields to rise above their current cap at 0.25%. Japanese yields would likely surge - as global yields have this year on inflation fears - causing the JPY to rebound sharply.
Source: Bank of Singapore, Bloomberg.
If the falling JPY keeps raising the cost of energy imports, then the BoJ may be tempted to let JGB yields rise. This would narrow the gap with US yields to the JPY’s benefit as the last chart shows. But a sudden change in the JGB yield target could induce a major shock as the Swiss National Bank’s removal of its CHF cap did in 2015. We doubt Governor Kuroda would take such a risk before his retires next year, especially as inflation in Japan is finally near the 2% goal he set in 2013.
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