The Bank of Japan has recently revised its yield curve control policy, which may result in an easier increase in interest rates. This development has prompted questions about how it will affect the Japanese Yen and carry trades that are widely used.
Throughout the year, the Yen has been weakening due to other countries raising their interest rates while Japan has kept them unchanged. Despite a headline rate of -0.1%, Japan uses yield curve control to keep yields under a certain level by purchasing bonds in the secondary market. Previously, they capped 10-year Japanese government bonds at plus half a percent, but they recently announced that this limit would now be flexible.
Despite this announcement, the market has surprisingly rejected Yen’s strength. Since the announcement, the Yen has weakened instead of strengthening.
The Bank of Japan’s credibility is being questioned due to its reluctance to increase rates compared to the US and Europe. While other countries have seen a 2-4% increase during their hiking cycles, Japan has only allowed for a minimal increase of no more than half a percent in the long run. This lack of change has left many people feeling dissatisfied.
The Yen has been affected by carry trades, where people borrow cheaply in Yen and invest in higher interest rate currencies like Mexican Pesos or EM currencies. Even the US Dollar is currently a high-interest-rate currency. There is a 5% interest differential between the Dollar and the Yen.
These trades have accumulated a lot of money and are heavily positioned. The MXN/JPY currency pair is particularly important for this trade, as Mexico is considered a relatively safe emerging market with high-interest rates. During the Silicon Valley bank crisis in March, this currency pair dropped 10% in just a few days. As a result, it is important to keep an eye on these trades, as the potential for large and powerful flows of money to be unwound exists.
MXN/JPY Long (Buy)
Enter At: 8.407
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