TOKYO - A repeat of the sharp yen appreciation seen in the summer of 2024 is unlikely under current conditions, with persistently high U.S. interest rates and continued structural pressure on Japan's currency making another rapid surge difficult, according to UBS wealth management chief investment officer Daiju Aoki.
Aoki said coordinated currency intervention alone is generally unable to reverse a lasting exchange-rate trend unless it is accompanied by changes in monetary policy or the broader economy. He expects the dollar to remain around 155 yen to 157 yen for the time being and views the current phase as potentially offering an attractive entry point into the dollar.
Japan has taken part in coordinated intervention on several occasions since 1990, including in 1995, 1998 and 2011. In 1998, when the yen weakened to around 147 to the dollar during the Asian currency crisis and a period of financial instability in Japan, the subsequent decline in U.S. interest rates helped push the dollar lower.
Following the Great East Japan Earthquake in March 2011, the yen briefly strengthened to around 76 to the dollar before coordinated intervention pushed the rate back toward 80 yen. With policy rates in both Japan and the United States largely unchanged, however, the exchange rate later moved mostly sideways, and a sustained weakening of the yen did not emerge until the advent of Abenomics toward the end of 2012.
The summer of 2024 was different. The dollar fell from around 161.7 yen to about 140.7 yen in less than two months, a move of more than 20 yen, as several factors converged.
One was a steep decline in U.S. long-term interest rates. The U.S. 10-year Treasury yield, which had reached about 4.7% in May 2024 and remained above 4% in July, fell sharply toward September as concern grew about an economic slowdown following the Federal Reserve's tightening cycle.
Political uncertainty in the United States also contributed to dollar weakness after then-President Joe Biden withdrew from the presidential race in July 2024. At the same time, the Bank of Japan delivered a rate increase on July 31 that had not been priced into markets, prompting investors to unwind short-yen positions and accelerating the currency's rise.
Aoki said those conditions are not present to the same extent now. U.S. interest rates are more likely to remain elevated, while factors weighing on the yen in Japan are unlikely to disappear quickly. He said another move comparable with 2024 would probably require a rapid shift toward global risk aversion.
One reason is U.S. inflation. Consumer price inflation reached 4.2% year on year in May before easing in June, but energy-related risks remain. Aoki said inflation could stay above 3% until around February or March next year, helping sustain expectations for further Federal Reserve tightening.
Markets have already priced in a substantial probability of another U.S. rate increase in September and further tightening through June next year, reinforcing the likelihood that U.S. yields will remain high.
Aoki also pointed to possible reforms at the Federal Reserve as another factor that could keep long-term yields elevated. Changes under discussion include reducing the frequency of Federal Open Market Committee communication and revising how economic forecasts are released, in an effort to reduce markets' excessive dependence on signals from policymakers.
Less predictable communication could increase volatility in interest rates, while changes to the Fed's balance-sheet policy and the pace of quantitative tightening could also place upward pressure on long-term yields.
A third factor is the rapid growth in artificial intelligence investment. Major hyperscalers including Amazon, Meta, Oracle, Microsoft and Alphabet are issuing increasing amounts of debt to finance data centers and other AI infrastructure.
A larger supply of corporate bonds competes for capital in fixed-income markets, placing upward pressure on yields. Aoki cited private-sector estimates suggesting the increase in issuance could be adding roughly 0.5 percentage point to U.S. 10-year yields, with some estimates approaching 1 percentage point.
Japan, meanwhile, continues to face domestic forces that can weaken the yen even as interest rates rise. Since around October last year, Japanese government bond yields and the dollar-yen rate have both moved higher, a combination Aoki linked partly to concern over fiscal expansion.
The concern is less about sovereign credit risk than the possibility that aggressive fiscal spending will add to inflation. At the same time, the BOJ's gradual pace of rate increases has raised concern that monetary policy may remain behind the curve, allowing inflationary pressure to persist.
A surprise BOJ rate increase is also becoming harder to deliver because investors are already pricing in substantial additional tightening. Aoki said the probability of a September increase from 1.0% to 1.25% had risen sharply from the level shown when his analysis was prepared.
Markets are also pricing in the possibility that the policy rate could eventually reach around 1.5% to 1.75%. That means the BOJ would need to move much more aggressively, such as raising rates by 0.5 percentage point at a time or signaling a substantially higher terminal rate, to produce the kind of surprise that helped drive the yen higher in 2024.
Aoki said such a move appears unlikely, particularly as wage growth has slowed from last year's pace. He also expressed doubt that the BOJ will actually raise rates in September, suggesting policymakers could instead use that meeting to signal a move before acting in October after reviewing additional inflation and economic data.
Ultimately, Aoki said the yen's longer-term direction depends less on intervention than on demand for the currency itself.
Japan's accommodative fiscal and monetary policies continue to increase the supply of yen, while demand has not risen enough to offset that pressure. A sustained appreciation would require stronger demand generated by factors such as trade surpluses, increased overseas purchases of Japanese equities and stronger earnings by Japanese companies.
Those developments, he said, depend on an improvement in Japan's industrial competitiveness and earning power. Intervention can slow or temporarily reverse currency movements, but without changes in monetary policy and economic fundamentals, it is unlikely to change the yen's underlying trend.
Source: CNBC
