As I gear up for an upcoming trip to Japan, my focus sharpens on the Japanese Yen. The currency’s trajectory influences my decision whether to exchange currency in advance of the journey.

Exploring the recent dynamics of the Japanese Yen, we find that last June, the Invesco CurrencyShares Japanese Yen Trust (NYSEARCA:FXY) grappled with a downward spiral. At the time, the Yen hovered near a psychological ¥145 level on the USDJPY FX rate. In response to the Yen’s nosedive, the Japanese finance minister pledged to intervene if the decline veered into the excessive territory.

In light of this looming government intervention, my advice to readers was to temper their bearish sentiment toward the Yen, particularly in the short term. Indeed, the Yen surged at the onset of July, as other currency speculators anticipated government intervention and covered their short positions (Figure 1).

Despite this, as no actual intervention materialized, the Yen quickly slid below the ¥145 mark until late October/early November. Subsequently, Japanese officials issued a caution to currency speculators as the Yen approached ¥150 (Figure 2).

This warning prompted speculators to retreat, propelling the Yen’s rally, buoyed by a global uptick in risk assets following the U.S. Federal Reserve’s pivot to a more dovish policy.

However, the rally proved short-lived, with weak economic data and high inflation exerting renewed pressure on the Yen. Recently, as the Yen approaches the ¥150 mark once again, Japanese financial officials are reiterating their stance against “rapid, speculative yen falls”.

With the Yen teetering near the ¥150 level, investors face the decision of heeding the warnings of Japanese officials or anticipating a breach of this critical threshold and further lows.

Understanding the Fund Essentials

For the unacquainted, the Invesco CurrencyShares Japanese Yen Trust mirrors the Japanese Yen’s value relative to the U.S. Dollar. This trust holds Japanese Yen and gains value with the Yen’s appreciation against the USD.

The FXY ETF offers a convenient avenue for investors to speculate on the Yen without transacting in foreign currency markets. With $300 million in assets, the ETF charges a 0.40% expense ratio (Figure 3).

The Downward Trajectory

Contrary to the assurances of Japanese officials, the enduring weakness of the Yen against major global currencies stems from the Bank of Japan’s decision to maintain Japanese policy rates at -0.1% even as other central banks raised interest rates since 2022. Compounding this, Japanese inflation has surpassed the central bank’s 2% target for nearly 2 years (Figure 4).

Elevated inflation and capped interest rates, a result of the BOJ’s commitment to purchasing unlimited amounts of government bonds to uphold 10-year yields near zero, have triggered capital flight, as investors flee from holding Japanese government bonds (“JGBs”). Following the Mundell-Fleming trilemma, policymakers in any given economy can only control 2 of 3 possible elements at a time: autonomous interest rate policy, fixed exchange rates, or unrestricted capital movement (Figure 5).

In Japan’s case, with capital freely flowing and the Bank of Japan stuck at -0.1% since 2016 (Figure 6), the release valve manifests as a depreciation of the Yen, which has been in freefall since 2021.

The Efficacy of Intervention

Curiously, the query arises: do currency interventions yield results?

In theory, a country like Japan, which issues its own currency, wields boundless power to devalue its currency as it can perpetually issue more Yen in exchange for foreign currencies. Conversely, Japan’s ability to appreciate its currency is constrained by its currency reserves, necessitating the sale of foreign currency to purchase Japanese Yen.

Official records indicate Japan possesses $1.25 trillion of foreign reserves, lending credence to its capacity for intervention. Historically, Japan has made multiple forays into currency markets to prop up and weaken the Yen (Figure 7 – incidentally, why does the U.S. label China as a currency manipulator but not Japan?).

In past interventions, the BOJ’s involvement typically signaled at least a short-term turning point, if not a multi-year shift in the Yen’s trend. Recently, the BOJ intervened in late 2022 to support the Yen as it sank to 24-year lows, sparking a multi-month rally in the Yen.