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Can the Three Arrows of Abenomics Drive the Yen Further in 2024?

February 6, 2024

In 2023, the US Dollar Index experienced a modest 2%decline, falling short of the previous year's robust performance. This was largely attributed to the Federal Reserve's aggressive stance in 2022, raising interest rates seven times from 0.5% to 4.50%. The frequency and magnitude of these hikes presented a challenge for investors accustomed to a prolonged low-interest environment since the 2008 global financial crisis. Additionally, with the world emerging from the pandemic, the unpredictable nature of economic recovery further justified a gradual slowdown in the Fed's rate hikes in 2023.

On the other hand, major currency economies, excluding Japan and Switzerland, tightened their monetary policies in response to domestic inflation pressures, narrowing interest rate differentials with the US Dollar. Despite these challenges, the US Dollar Index only saw a 2% decline in 2023,largely due to the overall weakness of the Japanese Yen, the second-largest component of the index.

The Yen against the US Dollar depreciated by 7% throughout2023, influenced by the Bank of Japan's dovish stance and yield curve control policy. Since the bursting of Japan's economic bubble in the 1990s, stimulating economic recovery has been a persistent challenge for the Bank of Japan. Former Prime Minister Shinzo Abe's "Abenomics," initiated in 2012, included aggressive monetary policies such as large-scale quantitative easing to counter the vicious economic cycle caused by prolonged deflation. These policies, including a 2% inflation target, unlimited quantitative easing, and negative interest rates, directly or indirectly contributed to the weakening of the Yen. Before the implementation of Abenomics, the Yen had remained strong, benefiting from the Asian economic concept and extremely low interest differentials with other developed regions. However, the Yen's strength turned into weakness, and the USD/JPY exchange rate, which was at a high of 110 in August 2008, plummeted to a low of 76 in early 2012, putting immense pressure on Japan's exports.

In 2022, Shinzo Abe was tragically assassinated, but his "three arrows" of Abenomics have been in play for over a decade. Itis now time to assess their effectiveness and see if they can continue to impact the Yen's future trajectory in 2024. Current data indicates that Japan's inflation rate remained consistently above 3% throughout 2023 (2.8% in November, with December data pending). The long-term average also reached2.42%, demonstrating the achievement of the 2% inflation target. However, when Haruhiko Kuroda took over as the new Governor of the Bank of Japan in April2023, investors anticipated significant policy changes. In reality, Kuroda did not bring about any major surprises, as the Bank of Japan made only two adjustments to the yield curve control framework in the second half of the year, downplaying the talk of unlimited purchases of Japanese government bonds but maintaining its negative interest rate policy. This move directly pushed the USD/JPY exchange rate higher, surpassing 150 in October and November.

While a weaker Yen benefits Japan's export-oriented economy, excessively low Yen levels also increase the risk of a sovereign debt crisis. Historically, when the Yen exchange rate was too low, the Bank of Japan intervened directly in the market. Although the Yen saw a significant rebound from mid-November's lows, this was driven by market expectations of the Federal Reserve switching to interest rate cuts in 2024 rather than anticipating a change in the Bank of Japan's policy. Thus, in the first week of the new year, the USD/JPY had already risen by almost 3%, emphasizing that the Bank of Japan's policy direction will likely determine the Yen's course in the coming year.

In addition to the achieved 2% inflation target and the global trend of interest rate hikes over the past two years, another crucial factor favoring the Bank of Japan's departure from its ultra-loose stance is the expected overall wage increase in 2024, likely surpassing the inflation rate. In early 2023, Japanese companies, led by major players like Toyota, implemented a wage increase of over 3%. Large domestic research institutes predict that salary adjustments in 2024 could reach 3.7%. If this overall wage increase materializes, it could provide a favorable tailwind for the Bank of Japan. Once this wind starts blowing, even before actual monetary policy changes, the Yen may have the potential to break free from its decade-long decline.

Looking ahead to the first half of 2024, it's worth noting that Japan will gradually introduce new versions of its banknotes. As someone who has always had a fondness for the ten-thousand-yen note, not only because it is the highest denomination of Japanese currency, but also due to the portrait of Yukichi Fukuzawa, a prominent figure in Japan's Meiji era. Fukuzawa was an educator and thinker who made significant contributions to modern Japanese economics, being one of the earliest individuals to introduce economic theories to Asia. His writings have had a profound influence on Japan's intellectual community. If you receive a ten-thousand-yen note with Fukuzawa's portrait, consider preserving it, and take some time to delve into his theories. It may yield unexpected insights in the future!

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