The recent decline in the Japanese yen has seen a weakening in the interest rate differential logic, and the current depreciation of the yen may be related to Japanese investors' overseas asset allocation activities. The speculative short-selling sentiment of overseas investors towards the yen is high, and the rise in import prices also puts pressure on the yen. The Bank of Japan has previously introduced market rescue measures, but the marginal effect of unilateral exchange rate intervention is gradually diminishing. The main driving force behind the medium-term correction of the yen is still the interest rate differential between the US and Japan, especially the economic data of the US and the动向 of the Federal Reserve.

The depreciation of the yen is not an isolated case; it is backed by a strong US dollar and the collective predicament of non-US currencies. Under a strong US dollar, the economic environment at home is difficult to determine the trend of the country's currency. Marginal monetary policy operations are also difficult to reverse the trend of exchange rates. Although it is also depreciating, the Chinese yuan has been relatively strong compared to other non-US currencies in this round; if the US dollar falls back later, the appreciation space of the yuan will also be compressed.

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On July 2, the yen exchange rate plummeted, and the yen-to-US dollar exchange rate hit a new low in 38 years, falling to 161.75 at one point, and the cumulative annual decline of the yen against the US dollar expanded to 14.8%.

I. Interest rate hikes and market rescues are difficult to stop the yen's trend of depreciation

The interest rate differential logic behind the recent decline of the yen has weakened. From 2022 to 2023, the dominant factor in the yen's trend of depreciation was the interest rate differential between the US and Japan, especially the economic data of the US and the动向 of the Federal Reserve. The yen basically followed the basic logic of "short-term depends on the Federal Reserve, medium-term depends on the Bank of Japan." However, since May 2024, the depreciation trend of the yen has deviated from the interest rate differential between the US and Japan. Under the background of the fluctuating downward trend of US bonds and the stable upward trend of Japanese bonds, the interest rate differential has gradually converged, but the depreciation trend of the yen has not been reversed.

The current depreciation of the yen may be related to the overseas asset allocation activities of Japanese investors. The correlation between the yen and US stocks has risen sharply since the first quarter of 2024. In January 2024, the government launched reforms to the Japanese Individual Tax-Free Savings Account (NISA) plan, enhancing the market's attractiveness to retail investors. NISA significantly expanded the annual investment limit, with the small investment limit increasing from 400,000 yen per year to 1.2 million yen, and the growth account's annual investment limit increasing from 1.2 million yen to 2.4 million yen. At the same time, it lowered the account deposit threshold to promote Japanese family investment. The expansion of NISA accounts has increased Japanese investors' preference for overseas assets. According to Nikkei data, the fund flow into foreign equity investment funds through NISA accounts in June set a new high, and the allocation of Japanese resident sectors to overseas assets continues to rise. From Japan's international investment position data, since the end of 2023, the equity security investment item in Japan's foreign assets has continued to rise. The demand for US dollar assets by investors may be an important factor in the recent weakening of the yen.

The speculative short-selling sentiment of overseas investors towards the yen continues to rise. In the current round of yen depreciation that began in the second half of 2021, financial institutions' speculative short-selling of the yen has played a role in promoting the trend, and the short-selling sentiment has become more intense after breaking through key points multiple times. According to data from the US Commodity Futures Trading Commission (CFTC), in the last week of June, the speculative short net position of the US market against the yen reached 174,000 hands, setting a new high for the short net position since data began in 2008, and there is no evidence yet that the market's expectations for the yen have bottomed out.

The demand for US dollars by Japanese domestic import companies remains high. Since 2023, with the evolution of the recovery of domestic demand in Japan, import demand has continued to remain high. Although the depreciation of the yen has driven a high increase in exports, trade has always maintained a deficit. Since 2024, with import prices stopping falling and returning to a positive growth range, Japan's trade deficit continues to expand. The demand for US dollars by importers is also one of the pressures for depreciation.

The marginal effect of unilateral exchange rate intervention is gradually diminishing. The exchange rate intervention by Japanese authorities can only slow down the speed of the decline and is difficult to become a decisive factor in the trend reversal. At the end of April and the beginning of May, when the exchange rate approached 160 for the first time, the Ministry of Finance conducted at least two exchange rate intervention operations, totaling about 98 trillion yen (62 billion US dollars), but the effect of the intervention is gradually decreasing. In early July, the yen broke through 160 again, and the market expected that a new round of intervention might be triggered near 165. The dependence of Japanese authorities on foreign exchange intervention is increasing, but as key points are continuously broken through, the market's confidence in intervention is gradually decreasing, and speculative transactions have not decreased.

The main driving force behind the medium-term correction of the yen is still the interest rate differential between the US and Japan, especially the economic data of the US and the动向 of the Federal Reserve. If the Federal Reserve cuts interest rates in September, it may become the time when the yen bottoms out. Japanese authorities generally have a high tolerance for the depreciation of the yen, but they have recently paid more attention to the negative effects of depreciation, believing that excessive depreciation has already done more harm than good to the economy. Previously, the Governor of the Bank of Japan expressed concern about the impact of exchange rates on inflation, implying that if the yen continues to depreciate, it may raise interest rates in advance. Slowing down the depreciation of the yen may become the main topic of the Bank of Japan's interest rate meeting in July.II. The depreciation of the Japanese yen is not an isolated case; it is backed by a strong US dollar and the collective predicament of non-US currencies.

Under the combination of high interest rates and a strong US dollar, non-US currencies collectively face the pressure of depreciation. Although the US Dollar Index briefly fell back in 2024, it has remained strong overall, driven by factors such as: (1) the European Central Bank, the Bank of Canada, the Swiss National Bank, and others have all initiated rate cuts, while the Federal Reserve has been slower to act. (2) In the first quarter of this year, although the US GDP growth rate slowed significantly on a quarter-over-quarter annualized basis, domestic terminal demand remained relatively robust, while the economic performance of Europe and Japan was relatively average, with no clear reversal signals for the US strong and Europe weak pattern. (3) The Russia-Ukraine conflict remains unresolved, and the situation in the Middle East has significantly deteriorated, with the US dollar still playing a safe-haven role. (4) Trump's election prospects have improved marginally, with his advocacy for tax cuts and tariffs being favorable for the US dollar's trend. Under a strong US dollar, not only the yen but also other developed and emerging market currencies have shown significant weakness, with exchange rate pressure becoming a common problem, causing certain disturbances to the stock and bond markets.

Referring to previous experiences and the current trend of the yen, there are patterns in the exchange rate trends of non-US currencies against the US dollar that are worth learning from:

First, under a strong US dollar, the quality of the domestic economic environment is difficult to determine the trend of the country's currency. Even with a strong domestic economic foundation, the currency will still face exchange rate challenges. For example, India's economy has shown strong performance in recent years, with its GDP growth rate and manufacturing prosperity both relatively higher than the United States, but the rupee still cannot escape depreciation.

Second, marginal monetary policy operations are difficult to reverse the trend of exchange rates. A recent example is the Bank of Japan's operations. Although it conducted tightening and interest rate hikes at the end of last year and in the first quarter of this year, the market found it hard to form expectations for long-term sustained interest rate hikes and lacked confidence in the economic trend of Japan, leading to a significant depreciation of the yen.

III. Although also depreciating, the Chinese yuan is relatively strong compared to other non-US currencies in this round; if the US dollar falls back later, the appreciation space for the yuan will also be compressed.

The Chinese yuan also faced depreciation pressure against the US dollar in 2024, falling from around 7.1 at the beginning of the year to below 7.25 at present, close to the low point of the third quarter last year. The core factor is still the overall depreciation trend of non-US currencies under a strong US dollar, in addition, the middle of the year is generally a seasonal weak period for the yuan. However, if considering the trend relative to other currencies, the depreciation amplitude of the yuan against the US dollar is actually low, and the fluctuation range is smaller. In the first half of this year, the average depreciation amplitude of global major currencies against the US dollar was around 4.7%, but the yuan only depreciated by 2.4%. Subsequently, as expectations for the Federal Reserve's interest rate cuts strengthen, the US Dollar Index has limited room for further increase. If the global economy improves marginally with the support of interest rate cuts, the US Dollar Index may gradually fall back, and the pressure on the yuan exchange rate is expected to be released, which will be beneficial for domestic monetary policy and stock market sentiment. However, due to its relative strength in the early stage, the appreciation space may also be limited at that time.

Unexpectedly high US inflation and economic growth lead the Federal Reserve to continue tightening monetary policy, causing the US dollar to appreciate significantly, US bond yields to rise, US stocks to continue falling, commercial bank bankruptcy crises, and emerging markets to face currency and debt crises. Unexpectedly severe US economic recession leads to a liquidity crisis in the financial market, forcing the Fed to turn to easing. Unexpectedly severe European energy crisis leads the Eurozone economy into a deep recession, global markets fall into turmoil, external demand shrinks, and policies face a dilemma. Global geopolitical risks intensify, China-US relations deteriorate beyond expectations, commodities and transportation face uncontrollable factors, the degree of deglobalization further deepens, supply chains continue to be disrupted, and resource competition worsens.