David T. Nudelman is partner & CEO at Scandinavian Capital Markets, a Swedish STP Brokerage for foreign exchange and CFDs.
Currency intervention is not a new thing. When China does it, the West calls foul. When Japan does it, it’s just another Tuesday.
But what is currency intervention? This process involves a country’s monetary authorities buying or selling their own currency in the foreign exchange market to influence its value. This is usually done to stabilize the currency, mitigate inflation or address other economic challenges.
Japan’s recent interventions provide a fascinating case study. The country has been fighting its inflation rate since the pandemic, like most Western countries have. One big difference in Japan’s inflation fight, however, is the country’s commitment to negative interest rates. For over eight years, Japan kept its interest rate at -0.10%, but in recent months, that all changed as the value of the yen dropped to a decades low against the dollar. The Bank of Japan then decided to adopt currency intervention as a strategy to mitigate its currency devaluation. (Spoiler alert: It did not work.)
‘Carry Trading’ Trend
When Japan was maintaining its negative interest rate policy while other countries raised their rates, forex traders saw an opportunity to short the yen while buying higher-yielding currencies such as the U.S. dollar, euro or British pound, a strategy known as carry trading. By leveraging the yen, which offered negative interest, against these high-interest currencies, traders could profit from swaps on FX contracts.
This strategy proved effective for many financial institutions and traders, thanks to the stable interest rates abroad and the prevailing trend of yen depreciation.
Japan’s Recent Intervention
In May, Japan’s Ministry of Finance confirmed for the first time since 2022 that the country performed a currency intervention on the yen. Between April 26 and May 29, the country reportedly spent roughly 9.789 trillion yen ($62.25 billion).
Other interventions are suspected to have happened in 2024 and 2023, but those have not been confirmed.
Japan Breaks Its Negative Rates Trend
In March, the Bank of Japan changed its strategy and raised its interest rate from -0.10% to 0.10%. The move came after months of unsuccessful inflation control and a huge devaluation of the yen against other major currencies.
The market reacted positively to the news, but skepticism around further interest hikes remained, keeping the value of the yen low, despite the currency intervention in the spring. At the end of July, the Bank of Japan increased interest rates to 0.25%, marking a definitive shift in its policy. The hike was good news for the yen, which strengthened “sharply” after the announcement.
Impact On Forex Traders
Although traders can still profit from selling the yen against higher-interest currencies such as the U.S. dollar, the trend has shifted, especially in light of the long-anticipated U.S. interest rate cuts.
That said, if you’re seeking currencies for carry trading, the yen remains a top choice for shorting due to its persistently low interest rate. However, if Japan raises rates again, the Swiss Franc could be a strong alternative. It’s one of the most stable currencies and, as of this writing, offers a relatively low interest rate of 1.25%.
A shift in the Bank of Japan’s policy could signal a return to the trends observed in recent years. However, with other countries gearing up to cut rates, this trend may be considerably weaker.
While carry trading with the yen is not obsolete, it has become riskier now that the yen is appreciating again.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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