The US dollar might be the most important currency in most people’s books but, right now, the yen is the dominant one.

A quick look at the effective exchange rate indices for the major currencies shows quite clearly that the yen’s 25% fall since the start of 2020 is the standout trend. The US dollar is higher than its 2020 starting level, but it has been lower in the interim, while the euro and pound have barely budged. Hence it is yen weakness that has really dominated; not dollar strength.

According to Mr. Steve Barrow, Head of Standard Bank G10 Strategy, there’s an example that shows this point quite clearly. It came when the Bank of Japan intervened in the FX market to strengthen the yen last September and October. For not only did this seem to kick off a period of quite rapid weakness in dollar/yen; it also saw the US dollar reverse its prior strength against other currencies as well. Of course, we are used to the US dollar moving in the same direction against different currencies but, in this case, our sense is that it was the yen that was the driver, not the US dollar.

Why is this important? Mr. Steve Barrow thinks it is crucial because a period of US dollar weakness in the future looks as if it will have to be generated by a rebound in the yen. To see this, it is worth looking at recent movements in international lending in different currencies, both in terms of bank lending and debt issuance. What we have seen here is that the yawning gap that’s opened up between policy rates and yields outside of Japan, and those inside Japan, has led to a surge in international yen lending.

In the past year yen lending has surged by 16% while dollar loans, for instance, have fallen by 2.4%. This is a notable change from the previous 20-plus years when dollar lending growth has outstripped that of yen lending. It is important to highlight this fact because the yen carry trade amongst short-term FX players does not appear to be the only – and maybe not even the most significant – driver of yen weakness.

This lending data, which comes from the BIS suggests more longer-term structural “carry trades” are being conducted as increasing numbers choose cheap yen funding over more expensive dollar loans for their businesses or investments. A key point about this type of yen borrowing, which is different from short-term speculative yen-funded carry trades, is that they are less likely to be scared off by intervention. That might help explain why the yen continues to fall despite the ever-present intervention threat from the government and BoJ.

If we take this forward it suggests that a turnaround in the yen does not just require short-term carry traders to give up, perhaps because of BoJ intervention. It also requires these more structural, long-term yen borrowers to shift back to other currencies and this is clearly where higher yen funding rates come into play if (or when) the BoJ starts to tighten policy. It would also see to require lower funding rates in other currencies, particularly the dollar, to provoke a shift out of yen funding and into other currencies.

One problem, however, is that these funding spreads are so wide between Japan and other countries that it could take some while for this particular playing field to level up sufficiently to create meaningful yen strength. But this is where shorter-term more speculative traders come in as their yen purchases, in anticipation of both tighter BoJ policy and looser Fed policy, could prompt a rally in the yen before any longer-term/structural changes in international yen lending develop. The bottom line is that the yen should make a comeback next year and, if the intervention episode of last year is anything to go by, it could help generate a decline in the dollar against other currencies as well.