Japanese Yen Falls to 40-Year Low Against Dollar; Traders Watch for Possible FX Intervention

The Japanese yen has just fallen through a historic floor, dropping to its lowest level against the U.S. dollar in nearly 40 years. For anyone trading currencies today, it’s like a time warp back to the mid-1980s.

The currency has kept falling despite a steady stream of verbal warnings from Tokyo’s top finance officials. The global financial community is now holding its breath to see if and when the Japanese government will stage a multi-billion-dollar market intervention to stem the bleeding.

The Problem: Interest Rate Discrepancies

The story behind the yen’s precipitous slide is a simple one of two very different economic paths. The US Federal Reserve, for example, has kept its interest rates at fairly high levels in a bid to stamp out inflation across the world. On the other hand, the Bank of Japan has been years in the making, keeping its interest rates near zero to help boost its own economy.

This gap is a golden opportunity for global investors to earn money. This has sparked a huge wave of what traders call the "carry trade". Investors are borrowing Japanese yen cheaply, selling it to buy U.S. dollars and then parking those dollars in high-yielding American assets such as government bonds. This persistent yen selling has built up a mountain of downward pressure that Japan's central bank has struggled to reverse.

Will the Government Step Up?

The currency market is tense, with the yen dropping to lows not seen for decades. For now, Japanese policymakers are sticking to their familiar script, saying they are watching the situation "with extreme urgency" and are ready to act against speculative, erratic moves.

But the market’s ability to spook is fast diminishing. Traders know Japan has opened its war chest before, spending billions of dollars on direct intervention to forcefully buy up its own currency and burn short-sellers. Many analysts believe the government is just waiting for the right moment to launch a massive, unannounced intervention that would shock the market and send the dollar scrambling backward.

The average person in Japan is feeling the pinch of this currency crash.

The good news is that a weak yen is great for big Japanese exporters such as Toyota or Sony, because it makes their products a lot cheaper and more attractive to buyers overseas. It has also made Japan a prime destination for budget-conscious international tourists, unleashing a flood of foreign spending in local hotels and restaurants.

But in the everyday families, the reality is painful. Japan is an island nation with no resources and imports the great majority of its food, energy and raw materials, all priced in U.S. dollars. The yen's buying power has eroded so badly that the cost of importing oil, natural gas and basic groceries has skyrocketed. This is squeezing household budgets and driving up inflation, leaving the government in a desperate balancing act trying to protect its citizens without destabilising its wider economy.