Japanese Risk

The macro point

It completely went unnoticed. Yet, it's a risk to consider. Japanese borrowing rates have been continuously rising for several months, reaching record levels for some maturities. Let's take the 30-year Japanese sovereign bond. Seven years ago, when the Bank of Japan (BoJ) practiced an ultra-accommodative monetary policy, its yield was at 0.10%. It was abnormally low for such a maturity. It is now at a high point of 3.40%. And it keeps climbing! This is also the case for shorter maturities, at 20 years or 10 years. How can this be explained? Normalization of monetary policy by the BoJ, concerns about increasing Japanese debt, and the growing reliance on debt by the Japanese government, which presented a new fiscal stimulus plan equivalent to 6% of GDP at the end of last year.

Why is this important for us? For years, Japan's ultra-accommodative monetary policy boosted the carry trade. In this scenario, investors, often institutional and hedge funds, borrowed cheaply in yen to invest in dollar assets (such as U.S. Treasury bonds or even stocks), and sometimes also in euros. All without coverage. The problem is, this works well as long as Japan maintains low rates. But that's no longer the case. The foreign exchange market is even anticipating a new rate hike of 50 basis points this year. This could trigger an unwinding of uncovered positions on the yen, in panic mode. This already happened in the summer of 2024. The BoJ caught the market off guard by raising its key rate. The yen was shaken, as well as other currencies and international stocks. This risk is still present. Is there a high probability of it materializing this year? Impossible to say. However, it does highlight the importance of adopting a hedging strategy and adjusting it when necessary.

Many analysts also point to the risks inherent in uncovered positions on the yuan. It's difficult to know if this is a systemic issue or not. We do not have access to aggregated data on the Chinese currency. However, it's something to keep in mind, especially if you are directly exposed to China.

Technical point

On the foreign exchange market, unsurprisingly, the situation was rather calm in recent sessions. Traded volumes were reduced, as is always the case during the Christmas break. Some central banks took advantage of this to intervene. This is certainly the case of the Chinese central bank, which, through public banks, pushed the yuan to a 15-month high against the US dollar. This confirms in passing that China is not seeking at all costs to devalue its currency.

For the main pairs, the trend remains unchanged. The EUR/USD, which is up 13% over the past year, continues its upward trajectory. The Bloomberg consensus anticipates that the pair could reach 1.20 in the second quarter. That's consistent. As for the EUR/JPY, the rise is still continuing. We do not rule out a surge to 188-190 in the coming weeks and months (compared to 183 currently). Finally, the monetary policy differential between the two sides of the Channel should continue to favor the euro against the British pound – although we have observed profit-taking over the past three months. We still have a short-term target of 0.89 against 0.87 currently.

Announcements to follow

US employment for December will be the main focus this week, as the US Federal Reserve (Fed) has signaled a cautious approach to rate cuts at its last meeting. Although there are still uncertainties about the extent of the upcoming cuts, it is likely that two new rate cuts totaling 50 basis points will occur in the first half. This would bring the benchmark rate between 3.00% and 3.25%. This is in line with the consensus. Future developments will depend, aside from the usual economic statistics, on the ability of J. Powell's successor to distance himself from Donald Trump. We know the market likes to play scare games. We doubt that a questioning of the formal independence of the Fed is a credible risk. The main issue is whether the new central bank president will be able to resist pressure from the executive. Powell was steadfast, lowering rates at his own pace. Some of his predecessors, sometimes physically pressured by the White House tenant, have bowed.

The information presented in this publication is communicated to you for informational purposes only and does not constitute investment advice, an offer to sell, or a solicitation to buy, and should not be used as the basis or considered as an incentive to engage in any investment.