Fed Continues on a Steep Rate Hike Trajectory While the Bank of Japan Maintains Negative Rates

Yesterday, the Federal Reserve increased its key rates by 75 basis points again, up to 3-3.25%. It’s the third increase of this size in as many meetings, and Fed Chair Jay Powell is warning the job is far from done, with more increases likely over the coming meetings. CNBC quoted an analyst as saying that “75 is the new 25 (basis point increases) until something breaks, and nothing has broken yet.”

The announcement led to a dip in the US stock market (right chart below from ActivTrades), as the median official expected interest rates for the end of the year and in 2023 have been reviewed upwards by the Fed’s projections. The USD climbed to a 20-year high (left chart below from ActivTrades), as many economists brace for a looming recession and homeowners continue to feel increased pain from rising mortgages and the cost of living.

In the meantime, Japan has decided to continue with its loose monetary policy with no increase in rates announced from the Bank of Japan’s two-day policy meeting which ended today.

Continuing to hold steady at -0.1%, and with no future increases in sight, the central bank is bucking the trend of tightening monetary policy around the world post-pandemic. It’s a significant contrast with other central banks, as the Bank of England, the Reserve Bank of Australia, the European Central Bank, the Reserve Bank of New Zealand, and of course the Federal Reserve, are all still lifting – or expected to continue lifting – their interest rates for the foreseeable future to bring inflation back to acceptable levels.

The BOJ is also continuing its policy to guide the country’s 10-year government bond yields to around zero percent in an effort to support the continued growth of the economy, while it’s expected that the pandemic relief program that kept small companies afloat is finishing up at the end of the month.

Japan’s headline consumer inflation, which excludes volatile fresh food, but includes fuel costs, is being impacted by the increase in commodity prices, sitting at 2.8%, and rising at its fastest pace in almost 8 years. The BOJ is confident though that this increase is merely transitory.

The expectation is for inflation to climb further to 3% by the end of the year, which is above the mandate of the central bank’s 2% goal but far below the majority of other developed nations.

The country’s annualized growth for the second quarter grew 3.5%, but it’s expected that it may slow slightly in this current quarter due to short-term increasing pressure from commodity prices.

So, why is Japan still keeping rates so low, and how is it impacting the country’s currency?

The Yen Continues to Fall but Things Might Change With the Intervention of the Bank of Japan

Following the announcement from the BOJ and the previous Federal Reserve’s announcement, the U.S dollar hit a 24-year high, rising around the 145 yen level on Thursday in Tokyo trading. The market sentiment indicator from ActivTrades shows that most traders are bearish on the currency pair (74 %) and expect the USD/JPY to continue rising (see the dedicated box on the left of the following chart).

It’s a trend that’s been building for a while now, as interest rates climb in the U.S and across the world as a result of runaway inflation, and investors move to purchase higher-yielding assets in these countries while selling off local currencies to do so.

As the interest rate differential widens between Japan and other countries, and more investors sell their Japanese currency to invest elsewhere, the value of the YEN becomes weaker due to less demand.

Local Japanese news reported the Bank’s Governor, Haruhiko Kuroda as saying that rapid fluctuations in the yen were “unfavorable,” that the continuation of low rates was still necessary as a measure to support the economy’s recovery, and that eventual rate hikes will probably be needed to stop the yen from continuing to fall against the USD, as it was a threat to the economy.

Things might change now that the Bank of Japan intervened for the first time since 1998 by purchasing the yen for the dollar.

The Japanese Finance Ministry said on Thursday that it has taken action to boost the yen by intervening in the foreign exchange market. The yen’s value has been declining against the dollar since March due to a widening disparity in the monetary policies of the United States and Japan.

Since the beginning of the year, the value of the dollar has increased relative to the yen by more than 20%, but today’s action by the Japanese government might release some of the selling pressure observed on the yen… but for how much longer?

A Slow Recovery in Progress Could Help Strengthen the Yen

Japan is slowly reopening after long periods of isolation from the rest of the world throughout the Covid-19 pandemic. Tourism ground to a halt in the popular destination as it did all over the world, but Japan has taken its time by lifting border restrictions inch by inch.

Analysts believe reintroducing tourism to the country will help reinvigorate the yen, as travelers rush to take advantage of the struggling weak currency.

Tourists could be forgiven for being wary of traveling back to Japan though, according to some, as the prolonged closures may have damaged the country’s reputation and policymakers and the local media blamed the spread of the coronavirus on foreigners entering the country.

Even though tourist groups had been accepted in recent months, the hoops that had to be jumped through to enter and the need for chaperoning with a guide while there have kept many from visiting.

The world’s third largest economy welcomed around 32 million foreigners in 2019, with plans to hit 40 million in 2020 before the pandemic hit, and according to the Nikkei Asia, it will hopefully open the border and remove the 50,000 person daily number restrictions among others in October after the full ban was imposed in November 2021.

Prime Minister Fumio Kishida spoke during an Economic and Fiscal Policy meeting on Wednesday, saying “It’s important for us to work to strengthen Japan’s earning power, taking advantage of the current yen weakness.”

With its major tourism industry hopefully heading back into full swing and the price of the yen being in such a weak position at the moment, it’s an interesting time for investors who might look at taking the opportunity to invest in the country.