Nikkei Up 20% YTD Despite BOJ Historic Hike

Despite the BOJ's recent rate hikes, speculation about potential government intervention has increased as the yen remains weak. With Nikkei closing the quarter 20% higher, what's next?

Why the Weakness in Yen?

Typically, a currency strengthens when interest rates rise. However, the yen weakened following the BOJ's historic decision to exit negative interest rates for the first time since 2007. The USDJPY exchange rate climbed to levels not seen since the early 1990s, coinciding with the stock market reaching new record highs. Several factors contribute to this counterintuitive outcome, as well as the rise in Japanese stocks against conventional expectations of rising rates.

In reality, the interest rate hike in Japan was modest. Governor Kazuo Kuroda reassured investors and politicians that rates would remain very low for an extended period. The bond purchase program was maintained to keep Japanese government bond (JGB) yields low. Meanwhile, US markets adjusted expectations of Fed rate hikes downward from six to three for the year, introducing uncertainty around later increases. This maintained the 350 basis point interest rate differential between Japan and the US, attracting carry trade activity. With BOJ policy decisions passed, carry traders reinvested positions with increased confidence in the near term.

What Happens Next?

A weaker yen benefits Japan's export-focused economy by boosting competitiveness and corporate revenues. Indeed, the weaker currency is fueling growth in Japan and stock prices. However, excessive currency weakness also raises import costs for a country highly reliant on foreign sources of food, energy, and industrial materials. Currency authorities are therefore concerned about potential overshooting that requires intervention as it could hurt the economy overall.

 So far, Japanese government officials have limited their response to verbal warnings about monitoring the situation and convening emergency meetings, likely attempting to influence market perception. A slightly weaker yen might be good for the Nikkei. Two years ago, the direct intervention of the BOJ currency market supported the yen. However, unilateral action required coordination with the Fed and ECB. With those central banks expected to cut rates later in the year, interest rate differentials should narrow and reverse carry trade flows. Therefore, Japanese officials may seek to delay yen weakness until that dynamic emerges.​

USDJPY in Cup-And-Handle?

The USDJPY currency pair halted its upward trajectory upon meeting resistance at 152, creating a double-top pattern in both the short-term and long-term timeframes. Combined with the 150.88 failure swing, this is reminiscent of a cap-and-handle pattern breaking higher. Should buyers successfully penetrate the top, Fibonacci projections derived from the 140.25-150.88-146.48 leg levels point to 153 as the next target. Above this, 154.86 and 157.14 represent the 78.6% and 100% projection ratios, respectively. However, the pattern may not be complete yet, with another handle possible. Failure to maintain support at 150.86 or a break below 150 could pave the way for a move to 149 or even a deeper retest of the trough at 146.48 again

Source: SpreadEx/ USDJPY

Key Takeaways

Despite recent rate hikes by the BOJ, the yen remains weak, fueling speculation about potential government intervention. The modest rate hike and reassurance of low rates from BOJ Governor Kuroda failed to strengthen the yen as expected, as interest rate differentials influenced carry trade activity, weakening the yen. While a weaker yen boosts exports and the Nikkei higher, excessive weakness raises import costs, which is concerning to authorities. So far, officials have only issued warnings to influence market perception, likely waiting for rate cuts by the Fed and ECB to narrow differentials and reverse carry-trade flows.