In a surprising turn of events, the Japanese yen has once again fallen drastically against the US dollarOn April 26, 2023, the yen depreciated by a staggering 1.73%, reaching an exchange rate where 158.35 yen is needed to obtain a single US dollarThis marks a more than 50% depreciation compared to its value over three years ago.

This isn’t the first time the yen has faced such volatilityThe currency underwent a rapid decline in 2022, when it first broke the 150 yen mark against the dollar, shocking the global financial communityAt that time, this drop was considered significant, but now that level appears to be merely the starting point as the yen continues to weaken further.

Japan does not implement strict foreign exchange controls, yet its central bank has not allowed the currency to drift completely uncontrolledIt is important to remember that no nation claims to be completely free from market intervention; a country’s currency is a symbol of its sovereign credit

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When a currency depreciates significantly over the long term, it can undermine a nation's image.

Just two years ago, when the yen plunged below 150 yen to the dollar, the Japanese central bank acted swiftly and implemented measures to stabilize the yen’s valueThese actions temporarily strengthened the yen, which rallied from 151.94 to 130.1 over a three-month periodHowever, the recent decline has seen officials seemingly indifferent to the yen's plight, exacerbating the drop further.

During a crucial interest rate meeting on April 26, the Bank of Japan decided to maintain its current interest ratesThe previous meeting had seen the new governor end an eight-year era of negative interest rates by raising the policy rate to a mere 0-0.1%. Surprisingly, this hike has failed to halt the yen's depreciation.

Market expectations had been high for another rate hike during the recent meeting, but the outcome shattered such hopes

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The gap between Japan's 0.1% policy rate and the United States' 5.5% rate is staggering, reflecting a substantial monetary policy divergence.

Furthermore, the Bank of Japan's statement notably excluded its commitment to buying 6 trillion yen of government bonds each monthThis omission has led to doubts regarding the bank's willingness to step in, putting additional pressure on both yen rates and Japanese government bond prices.

But why does the central bank appear resigned to watching the yen’s unexpected depreciation? The truth is that intervention may not be feasible due to three main reasons.

Firstly, raising interest rates could further weaken Japan’s already sluggish economyThe nominal GDP of Japan for 2023 has reportedly fallen behind Germany due to the yen's depreciation, pushing it down from the third-largest to the fourth-largest economy globally

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Despite this challenging landscape, Japan has finally begun to witness signs of overcoming a 30-year-long deflation.

After previously raising rates once, any hasty decision to do so again might backfire against economic interestsThe Bank of Japan forecasts a GDP growth rate of just 0.8% for the fiscal year 2024, a significant drop from the 1.2% prediction made in JanuaryAn increase in rates could stifle potential economic expansion, thus giving the central bank little confidence to raise rates aggressively.

Secondly, a weakening yen can benefit exportsA recent report by Japan's Ministry of Finance revealed that from April 2023 to March 2024, Japan faced a trade deficit of 5.89 trillion yen, marking its third consecutive year of trade imbalanceJapan’s economy is heavily export-oriented, and sustained trade deficits are unusualA weaker currency can promote exports, stimulating economic growth.

Indeed, in March, Japan’s export volumes increased, while imports decreased, resulting in a trade surplus of 366.5 billion yen for that period

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These numbers illustrate how a depreciating yen can positively impact export levels, potentially narrowing the trade deficit.

Thirdly, the trajectory of the yen is more tied to the Federal Reserve than the actions of the Bank of JapanHypothetically, if the BOJ raised rates consecutively, bringing them from negative rates to even 1%, immediate appreciation of the yen would be expectedHowever, without parity with the US's significantly higher rates, this short-term gain might be fleeting.

Even with rate hikes, the Japanese central bank cannot match the levels set by the United StatesInvestors may continue to prefer the dollar, leading to persistent depreciation of the yenHence, the real power to dictate the yen’s value may rest more with the Federal Reserve than within the confines of the Bank of Japan.

While many focus on the fact that current rates in the US are between 5.25% and 5.5%, one should not forget that just two years ago, rates were only at 0-0.25%. The difference was minimal then, resulting in a lack of incentive for investors to short the yen