The Japanese yen returns to the "danger zone"! The market is on guard against Japanese intervention measures. Financial power is still strong, but the key is to watch the reaction from the US.

As the yen falls back to a level that prompted the Japanese government to intervene a month ago, the market is reassessing Tokyo's remaining financial firepower and its political will to defend the weak yen. As of the time of writing, the dollar was trading at 159.27 yen. Japan's intervention in the foreign exchange market still has sufficient "firepower," but requires cooperation from the United States The Japanese government is suspected of conducting multiple rounds of buying yen in the foreign exchange market at the end of April and early May, totaling approximately $63 billion. This is only a small part of its foreign exchange reserves of about $1 trillion. However, traders believe that using all of the reserves or a large portion of them is not realistic. And as speculation bets against the yen heat up again, Japanese authorities also hope to continue to keep the market on edge. Daisaku Ueno, chief foreign exchange strategist at Mitsubishi UFJ Morgan Stanley Securities, said, "The more foreign exchange reserves shrink, the more vulnerable Japan appears to speculators." He pointed out that in the absence of any signs of easing pressure on selling the yen, "the psychological war between authorities and the market looks set to continue." Interventions to buy yen require the selling of foreign assets. As of the end of April, Japan held approximately $1 trillion in foreign assets. According to Goldman Sachs economist Yuriko Tanaka, based on calculations of data from the Bank of Japan's currency market, after deducting approximately 10 trillion yen (about $62.78 billion) used in actions in April and May, Japan still has approximately 150 trillion yen in reserves, enough for "about 30 rounds" of interventions. Although Japan still has a considerable amount of financial "firepower," depleting most or all of its overseas assets is not feasible, especially as this would have a negative impact on the value of U.S. Treasury bonds. This means that Japan's current actions require cooperation from the United States, just as the U.S. Treasury conducted a so-called "foreign exchange inquiry" in January to help push the dollar yen exchange rate lower. The Japanese government's interventions in the foreign exchange market at the end of April and early May have already provoked strong resentment from the United States. US Treasury Secretary Bennett has publicly criticized Japan's exchange rate intervention practices several times, explicitly advocating that Japan should stabilize the yen through interest rate hikes rather than currency intervention. The core concern of the United States is that Japan's exchange rate intervention funds mainly come from the sale of U.S. Treasury bonds, and continued selling of bonds could further raise U.S. bond yields and exacerbate volatility in the U.S. financial markets. With rising oil prices from the conflict in the Middle East and heightened global inflation concerns, U.S. bond yields are already on the rise, and Japan's selling of bonds is undoubtedly exacerbating the anxiety of the United States. With the continuous expansion of the U.S. fiscal deficit and the surge in bond issuance, the Trump administration will not tolerate Japan's policy deviations indirectly pushing up the already high U.S. bond yields. Atsushi Ueno, senior economist at NLI Research Institute, said, "U.S. understanding is crucial for maintaining the effectiveness of any intervention." He added that if Washington expresses opposition to such actions, it "may trigger speculative selling of the yen." Another factor that could limit Japanese authorities' interventions in the foreign exchange market is a standard set by the International Monetary Fund (IMF), that if a country intervenes too frequently in the foreign exchange market, it may lose its "freely floating" exchange rate status. However, Japan's top foreign exchange official, Junzaburo Mimura, has stated that IMF rules do not limit the number of times a government can intervene in the foreign exchange market. Akira Moroga, chief market strategist at Aozora Bank, said, "The current thinking is that curbing excessive volatility takes precedence over other considerations." He added that even if Japan loses its freely floating currency classification, "I don't think they would care at all." Japanese Finance Minister Gakuryo Katayama reiterated on Friday that he would not comment on whether his department had intervened in the market, only stating that officials are prepared to take "decisive action." Under the influence of the situation in the Middle East, the yen continues to be under pressure. Soaring energy prices have caused trade conditions to deteriorate for Japan, which is almost entirely dependent on oil imports, further exacerbating the yen's already weak trend. This is due to factors such as the Bank of Japan's cautious stance on interest rate hikes and market expectations for Prime Minister Sanae Takichi to introduce a larger fiscal stimulus policy. In addition, the situation of negative real interest rates is also one of the pressures faced by the yen. Unlike past Japanese governments that focused more on the speed of exchange rate fluctuations, the current government seems to be more focused on maintaining the level of "1 dollar to 160 yen." Now, some market participants are even starting to position themselves in advance, betting that the Japanese government will intervene again. A trader at a Japanese domestic bank said that buying of dollars is currently concentrated in the range of 155 to 157 yen, reflecting actual dollar demand from importers and speculative positions. It is widely expected in the market that the next round of Japanese government intervention will take place before the dollar reaches 162 yen. Another trader at a Japanese domestic bank said, "The government will do whatever it takes to maintain this level." Overall, in terms of policy prospects, international cooperation space, and market structure, the "effective space" for Japanese authorities to intervene in the foreign exchange market today is clearly more limited than in the rounds of interventions in 2022 and 2024. If the yen's decline becomes faster, more chaotic, and clearly deviates from orderly fluctuations, the Japanese Ministry of Finance may still enter the market, especially around 1 dollar to 160 yen or weaker. In terms of lasting effects, what could truly change the yen's softening trend is more likely to be a relaxation of the situation in the Middle East, a drop in oil prices, or the Bank of Japan raising interest rates earlier than expected to narrow the interest rate differential between the U.S. and Japan. Clouds over the prospect of Bank of Japan raising interest rates In addition to the potential intervention by Japanese authorities, the Bank of Japan raising interest rates may also help provide support for the weakened yen. At a time when inflation concerns and fiscal policy worries have caused Japanese government bonds to plunge, investors are closely watching whether the Bank of Japan will raise rates next month. Noriharu Hibino, deputy governor of the Bank of Japan, said on Tuesday that it is crucial to maintain market confidence through appropriate policy adjustments, and explicitly stated that the development of the situation in the Middle East will be a key factor in determining the timing and pace of interest rate hikes. Hibino said, "The key is to maintain market confidence, that the Bank of Japan will adjust the loose monetary policy at an appropriate pace based on the economic, price, and financial conditions, in order to properly control inflation." He emphasized that as Japan's real interest rates are still at extremely low levels, the Bank of Japan is expected to continue raising policy rates, but "the timing and pace of adjustments will be decided carefully through evaluating the probability and related risks of how the situation in the Middle East will affect the Japanese economy and prices based on the baseline scenario." On Wednesday, Bank of Japan Governor Kazuo Ueda said that vigilance is needed against how the surge in oil prices will impact the trend of core inflation, although he did not give a clear indication of how this dynamic may affect the outcome of the policy meeting next month. Ueda said, "Japan's experience shows that oil price shocks are not just oil price shocks. They are a test of the entire inflation system." The governor traced the impact of oil price shocks back to the 1970s and noted, "We are actually facing the fifth oil price shock." Consistent with standard practice, the Bank of Japan governor avoided issuing any public signals on the policy path. Nevertheless, given the concerns about the impact of high oil prices, Ueda's remarks may support widespread speculation in the market about the Bank of Japan's prospects for raising rates next month. According to overnight index swap (OIS) data as of Friday morning, traders are estimating a 77% probability that the Bank of Japan will raise rates at the June policy meeting. However, the unexpectedly slow growth in the core inflation index in Tokyo released on Friday may complicate the Bank of Japan's communication on policy. Data from the Ministry of Internal Affairs and Communications showed that the Consumer Price Index (CPI) for Tokyo, excluding fresh food, rose by 1.3% year-on-year in May. This marks the sixth consecutive month of slowing growth in this index, and is lower than all but one of the economist forecasts surveyed. At the same time, the index, which excludes fresh food and energy - a key measure closely watched by the Bank of Japan to gauge underlying inflation trends - rose by 1.6%. This index is considered to better reflect price trends as it eliminates interference from subsidies related to the government, but is still affected by some food price base comparisons due to the unprecedented surge in commodities such as rice last year. Price increases in processed foods have slowed from last year, a significant decrease in water service fees, and the government's implementation of gasoline subsidies have put downward pressure on this CPI report. The report indicates that the government's plans to successfully mitigate living costs also mask potential inflationary trends. Regarding this latest data, economist Taro Kimura said, "We believe that the Bank of Japan will see through the weakness of the overall data and remain vigilant about the upward inflation risks brought about by the increase in oil prices. We continue to expect the Bank of Japan to raise rates by 25 basis points to 1% in June." Analysts point out that with persistent inflation pressures, a depreciation of the yen exacerbating imported inflation, and a tightening global monetary policy environment, the Bank of Japan's interest rate hike in the next month is logically supported. However, there are multiple concerns for the Bank of Japan in its decision to raise rates. Firstly, the foundation of the domestic economic recovery is very fragile, and a rate hike is likely to further suppress weak domestic demand and corporate investment; secondly, Japan's government debt is massive, and raising rates will significantly increase financial interest payment pressure, jeopardizing debt stability; thirdly, financial institutions have heavy exposure to government bonds under long-term low interest rates, and a rate hike may trigger asset valuation losses, affecting financial system stability, while also balancing the pace with expansionary fiscal policy. In addition, political factors in Japan may also add variables to the tightening policy. Sanae Takichi has long supported loose monetary policy, and her inclination towards expansionary fiscal policies has, to some extent, pushed up long-term government bond yields and added additional pressure on the yen. Morgan Stanley Private Bank pointed out that under the dual pressures of high energy prices and fiscal expansion, the Bank of Japan may need to maintain a relatively loose policy stance to alleviate potential demand contraction. Therefore, some analysts believe that the Bank of Japan's most likely approach is a "slight rate increase, emphasizing gradualism." The Bank of Japan will not return to aggressive tightening, but will stabilize inflation expectations through a rate increase while avoiding a loss of control over long-term interest rates with dovish wording. However, the market does not rule out the possibility of the Bank of Japan once again "defaulting." Several institutions bullish on the yen It is worth noting that as the yen continues to remain weak, several institutions have recently given positive outlooks for the yen. Alberto Tamura, head of Morgan Stanley's Japan desk, said he expects the yen to strengthen to around 140 yen per dollar, with the key to achieving this target being a rate hike by the Bank of Japan in June. Tamura said that if the Bank of Japan does not raise rates in June, it will have an impact on bond and foreign exchange markets. He pointed out that the yen exchange rate could fall to 170 yen per dollar or rise to 140 yen per dollar, depending on how things develop, but he did not give a specific timeline. He said, "Some investors believe that it is important for the Bank of Japan to act without delay. If global conditions can stabilize, it will also help boost the yen." Mark Dowding, Chief Investment Officer for Fixed Income at RBC BlueBay Asset Management, said that the level of 160 yen per dollar is becoming "increasingly attractive" under the dual support of possible official intervention and expectations of a rate hike by the Bank of Japan in June. The company continued to increase its long yen position last week when the dollar fell back to around 160 yen. Dowding said, "We are confident that the Bank of Japan will raise rates in June. If the 160 level is broken, we still expect intervention." Looking ahead for the next one to three months, RBC BlueBay expects the dollar to fluctuate between 152 and 160 yen. Dowding has set clear defenses for this trading strategy: if the yen weakens to above 162 yen per dollar, they will continue to increase their positions; but if it breaks through 164, they may liquidate all positions - because this would mean that "the Bank of Japan and Sanae Takichi's policies are too dovish, or the Ministry of Finance's currency interventions have failed." Dowding said that if the Bank of Japan raises rates in June as expected, the dollar yen exchange rate is more likely to fall to the lower end of this range (around 152); whereas if the Bank of Japan's stance is more dovish, they may push the exchange rate back up towards 160. Stefan Jan, CEO of Eurozone SLJ Capital, and economist and fund manager Joanna Flaherty stated in a recent report that the yen is expected to strengthen against the dollar in the future, reversing the weak performance of the past few months. The institution believes that improvements in Japan's economic growth expectations, the possibility of the Bank of Japan continuing to raise rates in the future, and factors such as the Japanese government pushing for corporate reform and capital inflows could lead to funds flowing back into Japan and support a stronger yen. Additionally, the Japanese government has intervened in the exchange market several times recently to stem the yen's depreciation. Eurizon further pointed out that the Japanese authorities may even work together with the U.S. Treasury to intervene in the foreign exchange market in the future.