FXY ETF: Markets Seem To Have Expected Dovishness

The Invesco CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY) is an exchange-traded fund (“ETF”) that covers the Yen/USD exchange rate for a pretty reasonable cost of 0.4% in expense ratios. As an instrument to speculate, it seems to cost in line with direct Yen/USD trading on a typical brokerage, but we think that speculators should not be going long the yen with FXY for the moment.

The Bank of Japan (“BoJ”) confirmed today its ultra-dovish stance, and while it makes sense in the context of the local and global economy, the impact on the yen should be negative. While markets seem to have absorbed this information healthily for the time being, meaning dovishness remains expected from the BoJ, we think that the speculative factors against the dollar, most pressingly those around the debt ceiling, are likely to dissipate, meaning a latent hit could come to the yen. Not a good long play in our view.

Economic Breakdown

Let’s consider the facts for the moment. The BoJ engages in yield curve control, and has its tolerance bands for how high the rates should be allowed to go. As foreign economies raise their savings rates, people sell Japanese bonds. While this should raise yields in Japan, the BoJ commits to keeping market rates low by buying instruments when investors sell them. This keeps rates low across the Japanese economy and accommodates borrowing. While the BoJ had slightly relaxed the tolerance bands at the end of last year, they’ve confirmed they won’t relax them further. So far, there hasn’t been a hit to the yen nor to the FXY.

There are lots of good reasons for the dovishness. Firstly, there is less competition for resources, especially in Europe, which has been hard-hit by inflation and the war. This means inflation is less aggressive now, also as we lap the high figures of early 2022. Secondly, corporate culture in Japan supports employment security in exchange for limited raises. This means structurally limited risks of a wage-price spiral. Thirdly, Japan is pretty self-reliant. A depreciating yen hurts, of course, but not so much as imported inflation was evidently limited. Finally, Japan has a deflationary economy on account of demographics, so anything to hurt the consumer is especially risky there. Dovishness is going to be structural, and investors should realize that.

Across the Pacific, the situation in the U.S. is not so different in that inflation is easing. However, the Fed has the opposite view to the BoJ, and this is perhaps due to the dynamics of wages and of the labor market. The Fed has stated that rates will stay high for a while, and has stressed this as markets get excited on easing figures. While we believe higher rates aren’t necessary for much longer, and the U.S. is in for a soft landing, we think the Fed will keep rates high anyway and that markets don’t expect this.

There is another thing, which is the debt-ceiling crisis. While it’s unlikely that a default would happen, this is a speculative pressure on the USD that favors the yen at this moment. When this resolves, we think latent selling of the yen could kick in, compounded by the market’s realization that rates might stay higher, perhaps for a year longer, than expected in the U.S.

Bottom Line

Invesco CurrencyShares Japanese Yen Trust ETF isn’t that well positioned. While a recovery in China is an important factor that will benefit Japanese business, which is quite levered to the Chinese recovery on the industrial side, the dollar could make a comeback against a yen where the dovishness of the BoJ is continuing longer than expected, and where the Fed’s hawkishness could also continue longer than expected. While Invesco CurrencyShares Japanese Yen Trust ETF is a good speculative instrument that one could get back to, the timing appears to favor buying the U.S. dollar instead. The timing isn’t right for Invesco CurrencyShares Japanese Yen Trust ETF.