The Bank of Japan has lost its grip on the country's currency, and an interest rate hike from the U.S. Federal Reserve may be the only fix for Japan's economy.
Overnight, the yen hit 100.07, its strongest against the dollar in nearly a month. The strength comes after the Bank of Japan took the new and unusual step of implementing so-called "yield curve control", a policy that's designed to keep the 10-year Japanese government bond yield near current levels, around 0 percent. Most bonds issued by Japan have negative yields — meaning that bond buyers actually pay for the right to lend money to the government.
"It's a sign again for me they're running out of policy options," said Lee Ferridge, head of macro strategy, North America, at State Street Global Markets.
The yen has persistently strengthened against the dollar all year, despite the Bank of Japan's move in January into negative rates. Loose U.S. monetary policy that has kept the dollar soft, and shocks such as the surprise U.K. vote to leave the European Union, have pushed the yen higher as well. The Japanese currency has climbed more than 15 percent against the greenback so far this year and made export giant Toyota cut its operating profit forecast by a stunning 1.12 trillion yen ($11.1 billion) for the current fiscal year.
Dollar/Yen year-to-date performance
Source: Reuters Eikon
"Obviously the strong yen hurts Japanese companies," Ferridge said. A strong currency makes exports more expensive. "That's obviously what the Bank of Japan and the Japanese government are concerned about. The strong yen makes them less competitive than their international competitors."
While the central bank could attempt even more unconventional policy, he said, "really, the best alternative for the Bank of Japan is if the Fed started hiking rates and raising the relative rate spread."
If the U.S. Federal Reserve were to raise interest rates, that should strengthen the U.S. dollar relative to other currencies, including the yen. The Fed is on track to hike rates as early as December, in a gradual move toward tempering investment activity, unlike the increased economic stimulus efforts by the Bank of Japan and European Central Bank.
"Both central banks have been way slower and more timid in how they implement easing" compared with market anticipations, said Andres Jaime, global FX and rates strategist at Barclays.
As a result, even unconventional monetary policy efforts from the BOJ and ECB have shown a diminishing ability to weaken their respective regions' currencies.
Now as that realization sinks in, are "central banks willing to continue easing?" Jaime asked. "They say they are, but I'm not so sure how far they can go."
The Bank of Japan did not cut rates further into negative territory, as expected, but could ease further at its next meeting, set for October 31 and November 1.
The Fed kept rates unchanged Wednesday, as expected, but said in its statement that "the case for an increase in the federal funds rate has strengthened." Most market participants expect the Fed to raise rates in December.
"When the Fed should actually raise rates, the dollar should strengthen against the yen. Then you should see 105 (yen against the dollar)," said Stephen Simonis, Sr., chief currency consultant at FXDD Global.
The yen traded slightly weaker against the dollar, around 100.8 yen intraday Thursday.
"It appears to be stabilizing at lower levels," Marc Chandler, global head of currency strategy at Brown Brothers Harriman, said in a Thursday blog post highlighting currency moves after the Fed's Wednesday announcement.
Predictions for next year
However, the best the Fed may be able to do for the Bank of Japan is stall the yen's rise. Moves between the currencies are partly based on market expectations for future Fed hikes, and on Wednesday Fed policymakers cut their outlook to two hikes next year from a prior forecast of at least three.
Barclays' Jaime doesn't see the Fed tightening strongly enough to reverse the yen strength at all. He expects the yen to reach 99 yen versus the dollar by the end of this year, 98 in the first quarter of next year, and 92 by the third quarter of next year.
On the "Fed side, you need to have a central bank that would actually have a hiking cycle that would signal three to four hikes a year, and that would depend heavily on what happens with inflation," he said.
Another challenge when it comes to weakening the yen, said Carl J. Forcheski, director of corporate FX sales at Societe Generale, is that it is a safe-haven asset — meaning traders buy it when they're worried that other assets could fall.
"I think as long as we have such high levels of overall uncertainty, from global growth concerns, to markets questioning the effectiveness of this super-accommodative central bank policy (everywhere), to the U.S. Presidential election, and the simmering political tension surrounding the Middle East, the yen continues to react as a safe-haven currency, keeping it strong," Forcheski said.