Fidelity: Rewriting the yen narrative

January 20, 2023

The Japanese yen was in freefall last year. However, despite the Bank of Japan standing pat this week, we think recent tweaks to its yield curve control policy could reset the narrative and pave the way for the yen to gain.

As other major central banks hiked rates last year, the Bank of Japan was unmoved. The country has unique inflation dynamics and the BOJ saw no reason to deviate from its ultra-loose yield curve control (YCC) policy. The yen bore the brunt of this policy divergence with other developed markets, shedding nearly a quarter of its value against the dollar by October before recovering somewhat to end the year down 12 per cent to the greenback. 

The narrative started to shift on 20 December, when the BOJ made an unexpected change to YCC, widening the band in which it allows 10yr Japanese government bonds to trade to plus or minus 50 basis points, compared with the +/- 25bps band it set in 2021. While the official rationale for this move was to improve the functioning of the bond market, some interpreted it as a first step in a potential exit from YCC and toward policy normalisation.

Japanese banking stocks have surged in recent weeks and Japan’s government bond yields have also increased meaningfully, but the rise in the yen has been more muted. Despite the lack of further action by the BOJ in its policy meetings this week, we believe that the recent changes to the YCC policy could rewrite the narrative surrounding the currency. Bond markets are taking a more positive view of global duration now that inflation has peaked in the US and Europe; this should also support the yen, as will China’s reopening. The currency is still extremely undervalued, and it now appears to have strong risk-reward characteristics - we believe the potential upside outweighs the chance of further depreciation.