Yen’s Short-Term Fluctuations and Long-Term Weakness

Yen about 20 points weaker Than Its 2001-2013 Average

Source: author calculation based on data from https://www.wsj.com/market-data?mod=nav_top_subsection

The latest bump upward in the value of the yen following the US Federal Reserve meeting continues to follow both the short and long-term patterns of recent years.

In the short-term—i.e., the last few years--the yen’s ups and downs have depended primarily on the gap between the interest rate on ten-year government bonds in America and Japan. As the gap widens, money is lured from Japan to the US and investors have to sell yen to buy dollars. That lowers the value of the yen. When the gap narrows, as in the past few weeks, the opposite happens. Over the last three years, 95% of the daily ups and downs of the yen can be explained simply by the gap in interest rates (see chart below). Since the Fed indicated it may cut US interest rates next year, that would narrow the gap, especially if the Bank of Japan allows Japanese rates to rise.

Over the long haul, however, the yen’s value is determined by more fundamental factors in the real economy. The less competitive are exports from Japan in international markets, then the lower the price Japanese firms need to charge in order to sell them. That translates into a cheaper yen. So, even if the interest rate gap were to go back to where it was a couple of decades ago, the yen is unlikely to regain its past strength. In fact, at present, for any given gap between US and Japanese interest rates, the yen/$ is at leasst 20 points weaker than it was during 2001-13 (see chart at top of the blog).

Back in October, there was a 4.0% interest rate gap and the yen/$ was around 150. But back in 2001, the same gap produced yen rate closer to 127. Today, the gap is down to 3.25% and the yen at around 142. Back in the early 2000s, a similar gap produced a yen rate of around 120. Suppose the gap narrows to 2.5% next year. If current patterns hold, that would yield a yen/$ of around 125, compared to 100 in 2008.

As of October, the real yen—i.e. the purchasing power of the yen relative to that of all of its trading partners—was the weakest it has been in a half-century. Even if the yen were to strengthen 10-20% from its current level, it would still be significantly below its 50-year average (see chart below).

Source: Bank of Japan

That means Japanese households have to pay more for food and energy and companies have to pay more. More than 90% of the rise in prices seen over the past years has been in the import-intensive categories of food, energy, clothing, and footwear. All items other than food and energy are just 2% above their level in the spring of 2021 when this bout of inflation began.

Source: https://www.e-stat.go.jp/en/stat-search/file-download?statInfId=000032103842&fileKind=1

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