Is it safe to buy the Japanese yen after dropping toward a 24-year low?

Today is the ECB day, as the European Central Bank will release its statement. But despite the conflict in Ukraine, the euro is not at center stage when it comes to this year’s movements in the currency markets.

The Japanese yen is.

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According to Bloomberg, traders are the most nervous in years that the yen will keep falling. Given the pace of the yen’s depreciation, they should be.

It all comes down to the Bank of Japan’s yield curve control or YCC measures. This is a pro-cyclical policy and has only begun to deliver on what the Bank of Japan wants more – inflation.

The JPY is caught in a vicious circle

The movements in the JPY pairs may appear exacerbated, and for a good reason. After all, a quick look at the USD/JPY pair reveals that the main JPY pair traveled more than 3,000 pips (!) in about 1.5 years.

No matter how one looks at it, this is a staggering move. So should you buy the JPY after such a decline?

Not really. The trick is that the JPY only now starts to deliver on what the Bank of Japan wants. That is, higher inflation.

Also, the JPY is caught in a vicious circle.

Current market dynamics accelerate the JPY weakness

To many, the JPY weakness may look attractive for establishing a long position. But the current developments in financial markets suggest just the opposite.

Yields have risen, and higher yields lead to a weak JPY. This, in turn, leads to higher global yields due to the yield curve control and this, in turn, leads to an even weaker yen.

Let me put it more succinct.

As mentioned earlier, the YCC measures are pro-cyclical. Basically, the Bank of Japan is willing to do everything to control the rising yields – thus, it buys bonds and keeps policy easy.

But when global rates rise, the Bank of Japan has to do more bond-buying (i.e., quantitative easing) only to keep the local yields from not rising. Hence, the faster the other central banks tighten, the more easing from the Bank of Japan.

To sum up, the JPY pairs may give up some of their gains. However, any pullback should be only temporary.

With the Fed on track to raise rates by 100bp in the upcoming two meetings (half of it next week), and the ECB already pivoting towards a tight policy, the chances are that global yields will keep rising. Hence, the Bank of Japan will have no choice but to keep easing in the hope that inflation will finally pick up in Japan.

Be careful what you wish, they say. In this case, it may come true sooner rather than later.