Yen Slide Should Pick Up Steam; Some Old Market Forces Reassert Themselves to Weaken Currency
The yen is back on the path toward weakness, as some old market forces reassert themselves.</br></br>Prime Minister Shinzo Abe's economic plan launched in 2012---a combination of monetary and fiscal stimulus and long promised pro-growth economic reforms---sent the yen weaker and Japanese stocks soaring. Then in May, indications the Fed would scale back its bond-buying program, plus concerns about whether Mr. Abe would be able to follow through on the economic reforms, saw the yen regain strength. Abenomics was starting to look like previous failed attempts by Japan to shake off its 20-year slump.</br></br>But chalk up the yen's reversal to a temporary market digestive process. As a rule of thumb, higher U.S. interest rates attract Japanese yield-hungry investors to the dollar, causing the yen to weaken. All things being equal, if the Fed is set to tighten policy, and the Bank of Japan is set to loosen, then the dollar should rise against the yen.</br></br>But when investors dumped Treasurys last month, causing yields to rise in something close to a global bond panic, Japanese investors sold too, according to UBS foreign-exchange analyst Gareth Berry. The fall in prices overwhelmed any yield spread Japanese investors get from owning U.S. bonds. With more than $1 trillion in Treasurys, the second most after China, Japanese investors have a lot at stake. Meanwhile, Japanese yields stayed mostly firm, as the Bank of Japan ramped up its bond buying.</br></br>The selloff has left the difference between Japanese government bonds and U.S. bonds well above average. The gap between 2-year bond yields is 0.26 percentage points, compared with an average of 0.16 the past year. That might not seem like a lot, but Japanese have been starved of a decent yield for years. For 10-year bonds, the difference is more pronounced, 1.8 percentage points, versus 1.1 on average the past year.