Yen Showdown--Japanese Government vs Bank of Japan: Will Last Year's "Yen Carry Trade" Repeat?

As the yen continues to weaken, the Japanese government and the Bank of Japan have found themselves at odds over policy, prompting the market to recall last spring’s dramatic carry trade and its eventual collapse.

According to Chasing Wind Trading Desk, a Nomura report dated October 31 indicates that the Japanese government and central bank are currently engaged in a “game of chicken” over the issue of yen depreciation. The report suggests that Prime Minister Sanae Takaichi’s administration is essentially sitting on the sidelines, hoping that the Bank of Japan will take the initiative and consider the impact of a weak yen on inflation and act accordingly.

However, the Bank of Japan appears to be waiting for a clearer signal from the government. The report points out that foreign exchange policy falls under the jurisdiction of the government and the Ministry of Finance, and Prime Minister Sanae Takaichi has stated that the government ultimately bears responsibility for monetary policy.

The Japanese government and central bank are clearly at loggerheads over how to deal with the yen’s depreciation. Essentially, the government is observing from the sidelines, hoping the central bank will consider the impact of a weak yen on stable inflation and take action, while the central bank is waiting for the government to send a clearer message about the weak yen.

Against this backdrop, Bank of Japan Governor Kazuo Ueda did not indicate a clear hint of a rate hike in December at the latest meeting, leading the market’s expectation of a December rate hike to drop from the pre-meeting range of 50-60% down to 46%. This policy hesitation and delay has created space for speculators.

History Repeats? Beware the Sudden Reversal of Last Year’s “Carry Trade”

The current policy stalemate has investors recalling last spring’s market dynamics.

At that time, the “combination carry trade” — shorting the yen, going long on Japanese equities, and paying short-term yen swap rates — was widespread, once driving USD/JPY above 160. However, as the Bank of Japan unexpectedly raised rates in July 2024, these trades quickly reversed, causing USD/JPY to tumble to 140.

Nomura’s report warns that history could repeat itself. The report emphasizes that if the Japanese government and central bank are slow to respond again and allow speculative carry trades to expand once more, then when they do finally act, it could trigger a steep simultaneous drop in both the yen exchange rate and Japanese stock prices. The reportwrites:

“If the government and central bank only step in to curb a weak yen after speculators have significantly expanded their yen-and-Japan-equity carry trades, then the USD/JPY rate and stock prices could see a steep simultaneous decline — just like after the July 2024 meeting. It is vital the government takes action before this occurs.”

Speculators Still Have Ammo; External Pressure May Rise

Does the market have the conditions to repeat last year’s scenario? Data provided by Nomura’s report suggests the answer is yes.

In the week ending October 20, although Japanese equities rose by more than 3%, foreign investors’ buying was still “moderate.” Their cumulative net purchases amounted to only 58% of last summer’s peak, indicating that they “have not exhausted their buying power.”

The report’s authors believe that if the Japanese government continues with a “non-intervention” stance (essentially tacitly allowing yen depreciation), it could lead to external pressure. Given that the U.S. intervened orally when the yen depreciated sharply last year, the American government is very likely to engage in even more overt “verbal intervention” to urge Japan to act.

For investors, this means keeping a close eye on any policy signals from the Japanese government or the U.S.

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The above was wonderful content from Chasing Wind Trading Desk.

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