Japan's policy rate has surpassed Switzerland's for the first time in two and a half years, marking the end of its status as the lowest among major developed economies. This shift has prompted the market to reassess the yen‘s trajectory, particularly in the context of carry trades. Previously, investors leveraged Japan’s low interest rates for financing and allocated funds into higher-yielding assets. However, with Japan's rates rising, this strategy may be impacted. Concerns over further yen depreciation have eased, and the USD/JPY exchange rate has stabilized.
On March 19, the Bank of Japan (BOJ) announced that it would maintain its policy rate at 0.5%. BOJ Governor Kazuo Ueda stated that if economic and inflation trends align with expectations, further rate hikes could follow. In contrast, on March 20, the Swiss National Bank (SNB) cut its policy rate from 0.5% to 0.25%, making Japan's interest rate higher than Switzerland‘s for the first time. This development marks a significant shift from Japan’s previous position as the worlds lowest-rate country.
Can Carry Trades Continue?
Japan‘s low interest rates have historically made the yen a prime funding currency for carry trades. Investors borrowed yen at low rates and invested in higher-yielding assets to profit from interest rate differentials. This strategy often resulted in increased yen selling, putting depreciation pressure on the currency. Now, with Japan’s rates exceeding Switzerlands, the appeal of yen-funded carry trades may diminish, potentially reducing downward pressure on the yen.
In July 2024, speculative short-selling of the yen pushed the exchange rate to a multi-year low of 161.9 per USD. However, market analysts suggest that as Japan's interest rates rise, such extreme carry trade activities may subside, leading to reduced volatility in the foreign exchange market.
Despite breaking away from ultra-low interest rates, Japan still faces uncertainties. The BOJ's rates remain lower than those of other major economies, meaning the yen‘s potential for appreciation may be limited unless further tightening occurs. Additionally, global economic conditions, domestic inflation trends, and future BOJ policy decisions will all influence the yen’s outlook.
If inflation continues to rise, the BOJ may accelerate rate hikes. However, if economic growth slows, the central bank could adopt a more cautious approach to avoid tightening policy too quickly. Market participants should closely monitor Japan's economic indicators and BOJ statements, adjusting their investment strategies accordingly to navigate potential market fluctuations.
