Yen exchange rate appreciation to 120~125 in a year?

International Business News – The view that a slow appreciation trend of the yen will occur in 2023 has once again strengthened. The reason is that it is judged that while the global inflation momentum is gradually weakening, the real economy in Europe and the United States will slow down and go into recession due to the backlash of the sharp interest rate hikes, and the previously rapidly developing trend of yen depreciation will be reversed. Signs of financial turmoil as a side effect of higher interest rates are starting to emerge, which is pushing up expectations of a “slow yen appreciation”.

“The U.S. Federal Reserve Board (FRB) and the European Central Bank (ECB) have to be cautious about future interest rate hikes in order to avoid a financial system crisis that could have a serious negative impact on the real economy”. Ryutaro Kawano of BNP Paribas Securities issued such a report on March 28. With the bankruptcy of U.S. banks that cannot afford rapid interest rate hikes surfacing, the prospect of economic slowdown and recession in Europe and the United States is rapidly taking on realistic implications.

Just a short month ago, market sentiment was very different. At that time, given the results of consumer price and employment statistics that signaled prolonged inflation in the U.S., expectations surfaced that a prolonged interest rate hike situation and a widening of the Japan-U.S. interest rate differential would again accelerate the depreciation of the yen. At the same time, there is a growing view that higher import prices due to inflation will push Japan’s trade deficit toward normalization and support the yen’s depreciation from the supply and demand side as well. In the market, the voice of “aiming at 140 yen per dollar again” is getting stronger.

But the rising likelihood of financial turmoil spreading from the United States to Europe has wiped the atmosphere clean. Even if inflation persists, central banks in the US and Europe will have to hold back on raising interest rates. Dollar and euro purchases against the yen, which had been supported by expectations of long-term rate rises in the US and Europe, are also gradually being forced to correct.

In addition, the environment for yen depreciation in terms of supply and demand has also begun to change. The reason for the rapid depreciation of the yen in 2022 is the combination of the widening interest rate gap between Japan and the U.S. and Japan’s huge trade deficit. Japan recorded a record trade deficit of nearly 20 trillion yen in 2022 as the price of its exports failed to keep pace with the price of imports, mainly resources.

However, the rise in import prices, which led to the vicious depreciation of the yen, is also passing its peak. According to the Bank of Japan’s corporate price index, import prices continued to rise by nearly 50 percent from a year earlier until the middle of 2022, but gradually slowed down in 2023. Is rapidly converging on the rise in export prices. Despite the time lag, yen selling pressures on the supply and demand side are likely to abate.

Of course, it has not yet reached the point where the market believes that yen appreciation will accelerate. Koji Fukaya of Market Risk Advisory in Japan believes that “fears of a financial crisis will not spread significantly when only a few banks fail”. If just two mid-sized US banks flopped, it would not have a direct impact big enough to accelerate outflows from the dollar.

The problem is when the chain reaction of falling into bankruptcy amplifies things even further. The reason for the bank’s failure was that it could not withstand the rapid interest rate hike. It is undeniable that other banks have also suffered from the deterioration of their performance with the potential loss of large amounts of bonds. That said, the risk of an unexpected rumor leading to a massive loss of deposits hasn’t gone away.

Many market participants are painting a picture of exchange rates slowly moving towards yen appreciation as economies in the US and Europe move towards slowdown and recession. Fukaya said that as long as the financial turmoil does not worsen significantly, “the probability of appreciation to around Y120 to Y125 this year is high”.