Why is the Japanese Yen on a Rollercoaster?

The Japanese Yen has been hitting headlines lately, and for good reason. It's been steadily weakening against the US dollar, reaching multi-decade lows. But what's causing this, and why does everyone keep talking about US interest rates?

Reasons behind?

While Japan excels in high-quality exports like automobiles and have a strong tourism industry, these sectors alone haven't been enough to propel significant overall growth. Global economic slowdowns can decrease demand for these products. This dampens the positive impact exports can have on growth. According to the World Bank, in 2022, exports accounted for around 14% of Japan's GDP. While significant, it highlights that exports aren't the sole driver of growth.

A weaker Yen can be a double-edged sword. While it makes exports cheaper, it also inflates the cost of imported raw materials and energy, squeezing profit margins for manufacturers. Furthermore, Japan has a rapidly aging population, with fewer young workers entering the workforce. This means a shrinking consumer base and potential labour shortages. This limits the overall growth potential from domestic consumption. The Japan National Institute of Population and Social Security Research projects that by 2065, the population aged 65 and over will be over 38%. This shrinking workforce limits consumer spending and economic dynamism.

Japan is not currently in a recession (a period of negative economic growth), however, their growth has been sluggish, and deflation (falling prices) is still a concern. To boost a sluggish economy, Japan has kept interest rates ultra-low for years. This makes borrowing cheap, encouraging spending and investment.

Meanwhile, the US Federal Reserve is raising interest rates to combat inflation. This makes US dollars more attractive to investors seeking higher returns. Imagine interest rates are like interest on your savings account. The higher the rate, the more attractive it is to hold that currency.

The Result? A Dollar Bonanza:

Investors are pulling money out of yen-based assets and putting it into US dollars. This increased demand for dollars weakens the yen in comparison.

Is there a fix?

Lowering US rates could make the dollar less attractive, potentially causing investors to move back to yen. However, this is unlikely to be the sole solution. The Bank of Japan could buy yen directly to increase demand, but its effectiveness is debatable. More likely, they might cautiously raise rates themselves, as they did in March 2024. In the long term, Addressing the issues of aging population and higher national debt could build long-term economic confidence and ultimately strengthen the yen.

The future of the Yen:

The yen's fate depends on various factors, including the Bank of Japan's actions, US monetary policy, and Japan's overall economic health.

• Innovation and Productivity: While Japan is known for quality, some argue they haven't kept pace with innovation in areas like artificial intelligence and green technologies. This could make it harder to compete in the future which might have a significant impact on their exports.
  

• Global Interest Rates: The gap between US and Japanese interest rates is a major driver. If the US Federal Reserve slows down rate hikes or even cuts them, the dollar could weaken, allowing the Yen to rebound.
  

• Bank of Japan (BOJ) Policy: The BOJ's actions are crucial. Will they continue with cautious rate hikes or intervene more directly to support the Yen? Their decisions will significantly impact its value. If the BOJ raises rates and the US slows its hikes, the Yen could see a gradual appreciation over time.
  

• Japan's Economic Performance: If Japan can address its long-term challenges like the aging population and high debt, it could lead to a more robust economy and potentially a stronger Yen.
  

• Global Events: Unexpected events like geopolitical tensions or global economic crises can also influence currency valuations.