Classifying the yen regime after Japan's liquidity exit

Start with the liquidity exit

In March 2006 the Bank of Japan suspended its quantitative liquidity policy and said it would switch to interest-rate targeting with a 0-2% inflation reference range. The earlier quantitative-liquidity-target had been 30-35 trillion yen of commercial-bank current-account deposits, after policy rates had already been cut to zero in 2001.

Editorial reading: the exit opens a market-regime-classification problem. The task is to label whether the yen is still a cheap funding source, a surplus-supported currency, or in transition after policy normalization, not to treat dollar-yen as a standalone call.

Map funding-currency status

Fourth-quarter 2005 annualized GDP rose more than 5.0%, bank lending turned positive for the first time in more than five years, and consumer prices rose 0.5% in the year ended January 2006, the third consecutive annual increase. Short-term Japanese deposit rates were expected to stay near zero at first, then rise gradually from the third quarter of 2006 toward about 0.75% by year-end, leaving nominal yields still low versus the rest of the world.

Over the prior six months, carry trades borrowed low-yield currencies, especially the yen while short rates remained at zero, to fund higher-yield currencies such as the Australian and New Zealand dollars, the Brazilian real, and the Mexican peso, as well as commodities and energy.

Editorial reading: firmer activity, a turn in bank lending, and a third year of consumer-price increases sit beside a path that still leaves Japanese nominal yields low. Market-regime-classification still has to record the yen as a working funding currency until carry-trade use is shown to have faded.

Translate the US-Japan yield-gap

Five-year Japanese yields had reached a five-year high near 1.2% and ten-year yields near 1.7%, and a narrowing US-Japan bond yield-gap was treated as a historical intermarket condition that would support the yen. The ten-year dollar-yen yield-gap bottomed in the third quarter of 2004 and the cash dollar-yen rate reached a low near 102.0 early in 2005.

Editorial reading: currency-translation converts that yield-gap change into support or pressure on the exchange rate. Intermarket analysis then sets the translation beside carry-trade funding, policy liquidity, and the later dollar-yen range, rather than treating the gap as a standalone pair signal.

Read the dollar-yen range last

After that late-2004 and early-2005 push to 102, the pair later held a range described as more comfortable for Japanese policymakers as of mid-March 2006.

Editorial reading: comfort for policymakers describes the market setting. It is not, on its own, evidence that a new regime has replaced a carry-funding market. The range is classified only after funding-currency status and yield-gap translation are already labelled.

Keep surplus and regional conditions in the same frame

Japan's current-account surplus fell 7.6% in the year ending January to 719 billion yen, while foreign-exchange reserves exceeded 800 billion dollars, still held mainly in US Treasury bonds, and rising income-account receipts were identified as background yen support.

A firmer Chinese yuan, amid expected US political pressure for stronger Asian currencies before the November congressional elections, was viewed as liable to lift other Asian currencies and thereby support the yen, though Japan's export dependence meant regional appreciation would not automatically produce yen gains.

Editorial reading: intermarket analysis keeps the smaller surplus, the Treasury-heavy reserve stock, income-account receipts, and a firmer yuan in the same frame as dollar-yen. Those items help label surplus support versus cheap funding. They do not complete a pair forecast.