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 currently slightly lower against all major currencies except the Japanese yen. Yesterday, the buck moved up sharply for the second session in a row. Beyond the move higher, note that trading volumes in US dollar index futures accelerated compared to the previous session and relative to 30-day averages. This is a sign that traders bought the dollar with conviction. Today's US dollar index trading range is 94.30 - 96.60.
Following a significant move higher in the last two sessions, the buck is currently taking a breather. As risk sentiment continues to deteriorate, the dollar appears to have found buyers seeking safety. Yesterday, US equity markets resumed weakening, with the S&P 500 ending the day down by more than 1%. Growth-oriented indices, such as the NASDAQ Composite, fared even worse as the US growth outlook darkens. In currency markets, the euro was particularly weak against safe haven peers such as the yen and the Swiss franc. All else held equal, the dollar tends to strengthen in relative terms when 'risk on' currencies sell off.
Turning to the latest news, yesterday's Federal Reserve speakers suggested that the pace of future rates hikes may need to be re-assessed. Federal Reserve Vice Chairman Quarles called for a more gradual pace of rate hikes, suggesting that the Fed should deliver about one hike per quarter. "Absolutely, my path for policy is more gradual" than most other policymakers, he said. St. Louis President James Bullard also noted that continued rate hikes may result in a recession. Specifically, he suggested that the Fed may have to change course if tax cut-fueled growth begins fading in the near future. Following the significant equity market sell-off this month and thanks to recent weakness in economic data (e.g. September retail sales), the Federal Reserve is less likely to continue signaling tighter monetary policy.
While the dollar has benefited from the relative outperformance of the US economy over the past few quarters, the buck is likely to continue strengthening as US growth begins slowing in rate-of-change terms. As a safe haven currency, the dollar tends to the strengthen the most in response to slowing growth. Our outlook on the dollar remains bullish.
|October 15||NY Empire State Manufacturing Index OCT||21.10||19|
|October 15||Retail Sales YoY SEP||4.7%||6.5%|
|October 15||Business Inventories MoM AUG||0.5%||0.7%|
|October 15||Monthly Budget Statement SEP||$119B||$-214B|
|October 16||Industrial Production YoY SEP||5.1%||4.9%|
|October 16||JOLTs Job Openings AUG||7.136M||7.077M|
|October 16||NAHB Housing Market Index OCT||68||67|
|October 17||Building Permits SEP||1.241M||1.249M|
|October 17||Housing Starts SEP||1.201M||1.268M|
|October 17||Fed Brainard Speech|
|October 17||FOMC Minutes|
|October 18||Initial Jobless Claims 13/OCT||210K||215K|
|October 18||Philadelphia Fed Manufacturing Index OCT||22.2||22.9|
|October 18||Fed Bullard Speech|
|October 18||Fed Quarles Speech|
|October 19||Fed Kaplan Speech|
|October 19||Existing Home Sales SEP||5.34M|
|October 19||Fed Bostic Speech|
The Japanese yen is currently weakening against all major currencies. Yesterday, the yen moved up sharply against the US dollar. Notably, trading volumes in yen futures accelerated for the third session in a row, rising above 30-day averages. The combination of continued strength in the yen and accelerating volumes suggest that traders bought the yen with conviction. Today's USD/JPY trading range is 111.50 - 114.50.
As riskier assets such as equities and commodities rebound today, the yen appears to be weakening accordingly. Following a significant move higher in Chinese equity markets this morning, most US equity indices and commodities are strengthening. The S&P 500 is currently up by 0.5% while WTI (crude oil) prices are up by more than 1%. As as a safe haven currency, the yen tends to weaken in response to improving risk appetite.
Turning to domestic economic data, year-over-year September inflation figures decelerated relative to the previous month. While domestic inflation was rising in late 2017, cost pressures appear to be running out of steam this year. Between a mixed outlook for growth and inflation that remains directionless, the Bank of Japan is less likely to signal tighter monetary policy in the near future. All else held equal, the continuation of the status quo is neutral for the yen.
Lastly, Japanese Finance Minister Aso said that the US did not consider the country to be a currency manipulator. According to a Reuters story, Aso also stated that Japan-US trade talks are likely to begin in mid-January. While Trump's attempts to re-negotiate international trade arrangements have weighed on currencies such as the Mexican peso and the Canadian dollar in recent history, the Japanese yen has been unscathed so far. Our outlook on the yen remains neutral.
USD/JPY is currently trading above 112.40. EUR/JPY is up slightly, and trading above 129.10. GBP/JPY is up slightly, and trading above 146.50.
|October 15||Reuters Tankan Index OCT||28||26|
|October 15||Capacity Utilization MoM AUG||2.2%||-0.6%|
|October 15||Industrial Production YoY Final AUG||0.2%||2.2%|
|October 18||Balance of Trade SEP||¥140B||¥-438B|
|October 18||Exports YoY SEP||-1.2%||6.6%|
|October 18||Foreign Bond Investment 13/OCT||¥1016.9B||¥-200.3B|
|October 18||Stock Investment by Foreigners 13/OCT||¥52.6B||¥1577.4B|
|October 18||Imports YoY SEP||7%||15.3%|
|October 19||Core Inflation Rate YoY SEP||1%||0.9%|
|October 19||Inflation Rate Ex-Food and Energy YoY SEP||0.4%||0.4%|
|October 19||Inflation Rate YoY SEP||1.2%||1.3%|
|October 19||BoJ Gov Kuroda Speech|
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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.