USD/JPY, or US dollar to Japanese yen, is a heavily traded major currency pair. Given the significant trading relationship between the United States and Japan, USD/JPY is watched closely around the world. More importantly, Japan is the largest international creditor in the world, and the biggest foreign investor in the US. Given Japan's low growth and low interest rates, the yen tends to sell off during economic booms. During a downturn, the yen tends to strengthen sharply as yen-based investors sell their international investments and return to yen-based investments. As such, USD/JPY is seen as a proxy for global risk sentiment.
The US dollar is slightly lower today against major currencies today. The buck is currently the weakest against the euro and the Australian dollar. Yesterday, the dollar surged alongside rising US Treasury yields. Since mid-April, the dollar has been strengthening as US bond yields rise in anticipation of future rate hikes.
Looking at US Treasuries, 10-year bonds have finally managed to close above 3%. The bonds are currently yielding 3.031%. While the yield curve has been steepening in recent weeks, this is out of sync with the longer term trend. In the short-term, higher crude oil prices are driving inflation expectations. In turn, this is driving bond yields and the US dollar higher. In the longer-term, the yield curve is likely to resume flattening once the crude oil bull market runs out of steam or if US growth decelerates. As both growth and inflation are simultaneously accelerating today, expectations are rising for more rate hikes (helping the dollar). Our short-term outlook on the US dollar is bullish, while our medium-term outlook remains neutral.
USD/JPY is down slightly today and currently trading above 109.30. EUR/USD is up slightly and trading above 1.2170. The pound is up slightly, and GBP/USD is currently above 1.3940.
Looking at economic data and events from the US this week, traders will be paying close attention to upcoming Q1 2018 GDP growth figures. The Chicago Fed national activity index for March (0.1 vs. 0.27 expected) was below expectations. Existing home sales for March (5.6m vs. 5.5m expected), Markit services PMIs (54.4 vs. 54 expected), and manufacturing PMIs (56.5 vs. 55 expected) were ahead of expectations. S&P/Case-Shiller home prices for February (6.8% vs. 6.3% expected) and March MoM new home sales (4% vs 1.9% expected) were both ahead of expectations. Later today, we’ll see weekly initial jobless claims figures as well as durable goods for March. On Friday, the most important day, we’ll see Q1 GDP growth and Q1 personal consumption expenditures. We’ll also see the Michigan consumer sentiment index for April. Last week, the Fed’s Beige Book suggested that growth continues to accelerate at a moderate pace.
The Japanese yen is mostly lower today, and is selling off against all major currencies except the Australian dollar and the euro. Yesterday, the currency weakened alongside rising bond yields. Looking at USD/JPY, the pair managed to close higher despite overall weakness in the US dollar and a significant sell-off in the S&P 500 during US trading hours. While USD/JPY tends to track risk sentiment, the yen has become more sensitive to bond yields in recent times.
With limited news headlines and developments from Japan, the yen is mostly trading as a function of bond yields. As Japanese 10-year bond yields are fixed around 0% by the Bank of Japan, the difference between US and Japanese yields is just under 3% (as US 10-year bonds are currently yielding around 3%). While higher US yields have failed to weaken the yen in the past, interest rates have been driving currency markets since late March. As we have written before, this is because slowing global growth is reducing optimism for riskier investments. In the past, investors ignored rising US yields and chased investments such as technology and emerging market stocks. Today, rising US bond yields are hurting asset values as global growth decelerates. Our short-term outlook on the yen is bearish, while our medium-term outlook is neutral.
USD/JPY is currently trading above 109.20. EUR/JPY is currently up slightly and trading above 133.20.
Looking at Japanese economic data and events this week, the Bank of Japan’s upcoming meeting will be watched closely. The March Nikkei manufacturing PMI (53.3 vs. 52.6 expected) was ahead of expectations. The leading economic index for February (106 vs. 105.8 expected) was ahead of expectations. The All Industry Activity Index for February (0.4%) met expectations. Tomorrow, we’ll see foreign investment in Japanese equities and Japanese investment in foreign bonds. On Friday, the most important day, we’ll get the latest interest rate decision from the Bank of Japan, its outlook report and a press conference. We’ll also see the Tokyo consumer price index for April, the unemployment rate for March and March household spending. Finally, we’ll get March industrial production, and March retail sales, and March housing starts.
As USD/JPY makes gains, we are now bullish on the pair. Note that the pair is trading within a normal range in the short-term. This is based on various technical analysis tools on the daily chart.
As the pair rebounds, we are now neutral on USD/JPY in the medium-term. Looking at various technical indicators on a weekly chart, USD/JPY is trading within normal conditions.
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Significance of the USD/JPY pair
US dollar to Japanese yen is the second most traded currency pair in the world (after EUR/USD). Beyond Japan’s economic significance as the world’s third-largest economy (or fourth, if one considers the Eurozone to be an economic region), the country is also unique as it is the world’s largest international creditor. This means that Japan has more international assets versus liabilities. According to the Ministry of Finance, Japan’s net international investment position was ¥349,112 billion (almost $3T USD) at the end of 2016. The country’s position as one of the largest creditors to the United States drives trading in the USD/JPY pair. During economic booms, USD/JPY tends to weaken as yen-based investors seek returns outside Japan. In an economic downturn, the currency tends to strengthen as Japanese yen investors move their funds back into their home currency. Thus the US dollar to Japanese yen exchange rate is often seen as a barometer of risk appetite.
Relative GDP growth rates for the United States versus Japan are highlighted below:
2005 – mid-2007: The carry trade era
Prior to the global financial crisis, the yen was a popular funding currency for the carry trade. When currency speculators engage in carry trades, they borrow a currency with low interest rates (such as the yen) and invest the proceeds in currencies that offer relatively higher interest rates (such as the US dollar or the Australian dollar). In the early 2000s, the Bank of Japan set very low interest rates in order to discourage investors from holding the currency. As such, the currency was borrowed heavily by speculators in order to invest in high-yielding investments.
As the yen’s popularity as a funding instrument grew, the currency depreciated prior to the global financial crisis as a result. Looking at USD/JPY, the pair peaked in June 2007 around 124.
Mid-2007 – Late 2008: Build up to the crisis
Starting in the summer of 2007, currency speculators bought back the Japanese yen as fears grew regarding the health of the US housing market. As carry trades began unravelling, the yen began rallying. During this time, many believed that issues relating to the US housing market would be confined to the United States. Nonetheless, global risk appetite was falling during this time and yen-based investors sought to sell their international investments. After trading as low as 96 in March 2007, USD/JPY peaked around 110 in August 2008.
Late 2008 – 2009: The global financial crisis
By the summer of 2008, the US housing crisis had morphed into a global financial crisis. Most global currencies including the euro, British pound and the Australian dollar began selling off sharply relative to the US dollar. As we have described in a previous article, this is because global banks were raising funds by borrowing US dollars in Eurodollar (offshore US dollar) markets. These funds were used to invest in US mortgages and in international investments. Starting in 2008, lenders in Eurodollar markets began doubting the creditworthiness of many borrowers. As Eurodollar markets began freezing up, banks lost access to US dollar funding and the currency was in short supply.
Looking at USD/JPY, while the dollar rallied sharply in early 2008, the pair began selling off by August 2008. Relative to the US dollar, the shortage in Japanese yen was even greater. By the end of 2008, USD/JPY had fallen to around 87.
2009 - Late 2012: The world goes ZIRP
While Japan was the first country to experiment with zero interest rate policies (ZIRP), the US Federal Reserve also dropped interest rates to 0% following the financial crisis. Beyond ZIRP, the Fed also implemented several rounds of quantitative easing (buying bonds using its balance sheet) during this era. Prior to the crisis, the Bank of Japan had the loosest monetary policies, and this helped the yen stay weak. Following the crisis, many central banks were also running easy monetary policies, and the yen strengthened.
The Bank of Japan directly intervened in currency markets four times between 2010 and 2011 in order to weaken the yen. Yet the interventions had a limited impact on USD/JPY, and the exchange rate continued to fall throughout this time. In October 2012, USD/JPY was trading around 78.
Late 2012 - 2016: Abenomics and Kuroda
2012 was an election year in Japan, and a general election was scheduled for December. The ruling Democratic Party of Japan government was highly unpopular following increases to consumption tax amid a slowing economy. Shinzo Abe, the Liberal Democratic Party candidate, campaigned on a platform of “Abenomics”. Inspired by “Reaganomics” (the economic agenda of former US President Ronald Reagan), Abenomics comprised of three priorities: (1) substantial monetary easing, (2) fiscal spending and (3) economic reform. As Abe rose in the polls, currency traders began increasing their bets on more monetary easing from the Bank of Japan. As a result, USD/JPY began rallying sharply.
This time, currency markets accurately predicted Abe’s victory, and the yen continued to weaken. By April 2013, the exchange rate had strengthened above 100. Remarkably, the yen weakened even as the US Federal Reserve launched QE3 (its third round of quantitative easing following the crisis).
Following the appointment of Haruhiko Kuroda as governor of the Bank of Japan, the BoJ unveiled a substantial monetary stimulus program. Kuroda announced that the Bank’s balance sheet would double in size by the end of 2014, and committed to open-ended asset buying. Specifically, he used the Bank’s balance sheet to purchase government bonds, corporate bonds as well as Japanese equities. The BoJ also abandoned its interest rate target and instead chose to target the size of the monetary base instead.
In late 2014, the sharp decline of crude oil prices resulted in further yen weakness. Beyond falling crude oil prices, the Federal Reserve was signaling a tightening bias in the future. As the Eurozone and Japan remained committed to quantitative easing and negative rates, the US dollar soared as a result. USD/JPY ended 2015 around 117.
2016 – 2017: Risk off/risk on
At the outset of 2016 (following a Fed rate hike in December 2015), global risk appetite began declining following poor US GDP growth figures. The upcoming Brexit referendum and US presidential elections later in the year also had markets concerned. As such, investors bought safe haven assets such as bonds and gold. Given the yen’s safe haven status, the currency also began strengthening. Looking at USD/JPY, the pair weakened to 100 following the Brexit vote in June 2016. The yen remained fairly strong until the US presidential elections.
In September 2016, the Bank of Japan reverted to targeting interest rates instead of the monetary base alone. This time, the Bank implemented a policy known as ‘yield curve control’ (YCC). As per YCC, the Bank of Japan maintained 10-year government bond yields at 0% by buying and selling bonds. If bond yields were to rise above 0%, the BoJ was willing to issue an unlimited number of bonds in order to drive yields down to its target. This made the currency exceptionally sensitive to global interest rates. In a recent take on the BoJ’s policies, we wrote that Kuroda was likely to signal the end of YCC in 2018.
Donald Trump’s victory in the US presidential elections came as a surprise to many, and the yen initially strengthened. A few hours following his victory, markets began betting on higher growth and inflation. This was particularly the case once the Republican Party gained control of both houses of Congress. As bonds and gold began selling off, the yen soon followed. By December 2016, USD/JPY was trading above 118.
After rallying in the previous year, the US dollar performed very poorly in 2017. As Trump failed to pass healthcare reforms in early 2017 and inflation came in below expectations, the US dollar sold off accordingly. As we wrote in late 2017, sustained USD strength is unlikely without better inflation figures. USD/JPY gradually weakened in 2017 and ended the year just above 112.50.