(Jan 21): Fears of steep government spending and resurgent inflation in Japan are driving a breakdown in the yen’s traditional link to the dollar and government-bond yields, prompting HSBC Holdings plc strategists to reverse their forecasts for the Japanese currency in the months ahead.
Global investors typically think of the yen as closely correlated to interest-rate differentials, finding support as spreads narrow to US Treasuries.
But that paradigm hasn’t held up in recent months. In fact, the yen has fallen some 7% versus the dollar since the start of October — despite the yield gap narrowing nearly 60 basis points between the 10-year Japanese government bond and its US counterpart.
“This ‘wedge’ between the two reflects a widening ‘risk premium’ for the yen,” a team of HSBC currency strategists including Paul Mackel and Joey Chew wrote in an annual outlook.
Among the investor concerns driving “structural yen weakness” following the election of Prime Minister Sanae Takaichi last year are debt monetization, weakening purchasing power, and persistent inflation and negative real rates, the analysts said.
Those concerns were evident in the JGB selloff on Tuesday that sent yields soaring, prompting Japanese Finance Minister Satsuki Katayama to call on market participants to calm down. Meanwhile, the yen underperformed all Group of 10 peers, weakening marginally to around 158 per dollar, even as the greenback fell broadly in a “sell America” trade, with US stocks and bonds falling.
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The catalyst now for the yen’s “sudden reckoning” is two-fold, according to HSBC analysts. First, the pickup in Japanese inflation that began in earnest in 2022 and second, Takaichi’s rise to power in October. The prime minister has since called for a national snap election in early February to cement her pro-stimulus economic policies, including a planned record initial budget of some ¥122.3 trillion (about US$775 billion at current exchange rates).
HSBC now forecasts the yen to weaken to the 160 per dollar mark by the middle of the year, instead of strengthening to the 150 level as the strategists expected previously. Complicating factors is the real possibility of intervention in the currency markets by Japanese authorities to support the yen should it fall below 160, the strategists said.
Mackel, Chew and team see a few potential factors that could halt the yen’s near-term decline — with the most viable, like a slowddown in the US economy, outside the control of Japanese policymakers.
Uploaded by Isabelle Francis
