At the end of April, the yen tumbled to near 160 to the dollar – its lowest in 34 years. The Japanese authorities appear to have intervened by buying U.S. dollars, warning investors betting against the yen and helping slow its slide. Any near-term drivers aside, we think the yen’s weakness is caused by the gap between Fed and Bank of Japan (BOJ) policy rates. The Japanese currency started depreciating in 2022 as the Fed started hiking rates rapidly. Its fall accelerated in April as the BOJ affirmed it would not rush to unwind its loose policy, while markets pared back their pricing of Fed rate cuts for this year given sticky U.S. inflation. Government bond yields for the U.S. and Japan reflect that gap in the market’s monetary policy expectations. Ten-year U.S. Treasury yields have surged above Japanese government bond yields, with the difference close to two-decade highs. See the orange line in the chart.
Yet we think that gap between U.S. and Japan 10-year yields could narrow again as BOJ and Fed policy rates begin to move closer to each other. Sticky U.S inflation may mean the Fed will keep interest rates high for longer, but we still see it starting to cut them later this year. And the BOJ is likely to hike rates again as it cautiously normalizes its emergency policy of negative interest rates. That should ease pressure on the yen. That said, should the yen weaken significantly between now and then, it could stoke inflation as the cost of imported food and energy rises. The BOJ could respond by tightening policy more rapidly. But we think that’s unlikely as it would risk threatening an improving growth outlook, and victory in its decades-long battle against no or low inflation is not yet assured. We see government subsidies on food and energy as a more likely response.
The impact of a weak yen
A weak yen affects Japanese firms differently. Manufacturers with higher input costs may see lower earnings. Yet as Japan’s goods become cheaper for foreign buyers, that will benefit the exporters that make up over half the market capitalization of Japan’s TOPIX index. As recent wage negotiations lead to higher wages, a strong consumer could support some sectors.
Japanese stocks have surged, based on the excess yield that investors receive for the risk of holding them over bonds. But we stay overweight Japanese stocks on a six- to 12-month, tactical horizon. The rally is a sign investor confidence is perking up. And a weaker yen doesn’t change the reasons behind our positive stance. The return of inflation in Japan means companies can raise prices and expand their net profit margins. Plus, shareholder-friendly corporate reforms are taking root, with more firms joining the Tokyo Stock Exchange’s list of those with plans to improve their governance. Government initiatives to encourage more domestic savers to invest could boost flows into Japanese stocks. These shifts are playing out over time. We also see mega forces – big structural shifts driving returns – creating long-term opportunities in Japan. For example, Japan’s population has been aging for many years. That has propelled efforts to adopt automation to boost productivity.
Our bottom line
We see diverging monetary policy driving the slide in the yen, but we don’t see the pressure persisting. We stay overweight Japanese stocks given ongoing corporate reforms and eye opportunities created by structural shifts.