Yen Languishes Despite Intervention and Rate Hike, Structural Factors Bite

Japanese Finance Minister Satsuki Katayama is increasingly finding herself in an unenviable position on the foreign-exchange front.

After deploying over 11.7 trillion yen ($72.8 billion) in foreign reserves to prop up the currency from April to May and the Bank of Japan raising policy rates to a more than three-decade high, the yen still languishes at the 160 level against the dollar.

Masahiko Loo, senior fixed income strategist at State Street Investment Management, said that the rate hike was widely expected, making it a little more than a "Band-Aid on a bullet wound" for the yen.

Furthermore, Japanese officials including Katayama signaled multiple times in early June that Japan was prepared to take "decisive ‌action" against excessive volatility in the yen — ironically, that very signaling helped reduce the element of surprise, and by extension, the effectiveness of any intervention.

"Policymakers have telegraphed their warning so clearly that a preemptive strike might only bring fleeting relief," said Loo.

On April 30, the yen appreciated sharply to 156.6 from 160.39 against the greenback, prompting speculation that Tokyo had stepped into the market. The currency strengthened to around 155 the following day, only to start weakening again.

To stem the slide, experts told CNBC that Japan was likely to have intervened again during Japan's Golden Week holidays in early May when yen was around 158. That did not stop the currency, however, from drifting back toward the 160 level.

The reason why the intervention and the rate hike have not helped rein in the yen slide is owed to structural factors dogging the currency.

While the BOJ is tightening policy, Nomura's chief strategist for market strategy research Naka Matsuzawa said in a note on Wednesday that U.S. bond yields remain high, which makes the so-called carry trade still attractive.

Carry trades refer to investors borrowing in a currency with low interest rates, such as the Japanese yen, and investing in higher-yielding assets elsewhere.

The yield on the 10 year JGBs is currently at 2.64%, while 10-year U.S. Treasury yields are at 4.451%. That difference is enough to keep the carry trade going.

Another factor is also politics. Matsuzawa said that the administration of Prime Minister Sanae Takaichi has a reflationary stance, favoring an easy monetary policy to propel growth in Japan. And that clouds the policy outlook, keeping fund inflows into Japan in check.

The Japanese prime minister in February had nominated two academics, who reportedly have a dovish stance, to the BOJ's board. Members Toichiro Asada and Ayano Sato belong to a group of reflationists who have advocated expansionary fiscal and monetary ideas, according to Reuters.

Asada is now on the BOJ board, and had cast the sole dissenting vote on Tuesday when the central bank hiked rates. Sato will succeed board member Junko Nakagawa at the end of June.

Japan's heavy reliance on imported energy at a time when the Iran war has kept prices elevated have also pressured the yen, as the country buys dollars to purchase energy.

"FX intervention is conducted to curb a rise in volatility and to deter speculative yen-selling by market participants. For now, the authorities are likely still at the stage of closely monitoring price action," Hirofumi Suzuki, head of research group at Sumitomo Mitsui Banking Corporation, told CNBC.

In the short term, however, chances of intervention remain high. "The market's speculative short JPY positioning has risen further, beyond levels seen before the Golden Week interventions," Nomura's Matsuzawa said.

The resolution of the Middle East war following a deal between the U.S. and Iran, and resumption of shipments via the Hormuz Strait, will help cut energy import bills for countries such as Japan and reduce currency pressure.

State Street's Loo said longer-term flows also could become more supportive for the yen, as AI-related investment, foreign interest in Japanese equities and a technology-driven Nikkei rally attract capital into Japan.