In a rather unsurprising move, the Bank of Japan once again today broke an earlier commitment made to the Group of Seven back in 2013 by intervening directly in foreign exchange markets to devalue the Yen following an earlier surge higher versus the US dollar. After pledging alongside other developed nations to avoid at all costs a currency war aimed at competitive devaluation, the increasingly desperate set of policy actions undertaken by the Bank of Japan hearken to an institution that is quickly losing control. The weakness in the dollar on the back of the latest FOMC decision has raised the risks for Japanese policymakers eager to restore inflation by implementing progressively more aggressive measures. So far, the intervention has been nothing short of a disaster, with the probability of additional action rising as the Bank of Japan works furiously to defend the line drawn at 111.00.

Fundamentally Speaking

Japan’s foray into negative interest rates, although a more recent entrant, has already failed to produce the desired results as evidenced by the momentum higher in the Yen versus peers. Even though the initial announcement sparked a temporary respite from the Yen buying pressure, the impact proved short-lived. Typically the 110.00-115.00 level would be viewed as ideal from a local exporter’s perspective, however, for the Central Bank, this range would not be suitable to accomplish the inflation mandate. The Bank of Japan has already warned markets that the economy was unlikely to meet the inflation objective in 2016, meaning that any effort to reverse declining inflation will likely be met with failure. The market in particular has not reacted kindly to these developments, with increased volatility in Japanese bonds and an ongoing Yen appreciation.

Adding to mounting Yen problems facing Japanese officials is the less hawkish stance of the US Federal Open Market Committee. The decision by the Federal Reserve to leave interest rates unchanged came as little surprise, but the revised outlook for rates was enough to send the dollar spiraling lower against peers, sparking a move to safety assets and a further unwinding of the USDJPY carry-trade. Weaker macro data combined with softening inflation and rising anxiety about the global economy saw the FOMC reduce rate projections to 0.875% by year end, meaning expectations of only two rate increases versus earlier estimates of four during the calendar year. Nevertheless, fundamentally speaking, the US shows immense promise compared with the Japanese economy considering the tightening direction of policy while Japan tests the limits of loosening.