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The Japanese yen fell to a seven-year low of 125 against the US dollar on Monday as the Bank of Japan continued easing its monetary policy further widening the gap with the US Federal Reserve’s hawkish tone.

But instead of seeing it as a threat to the Japanese economy, the BOJ reiterated that a weaker yen would have positive effects on pushing Japan’s GDP higher.


BOJ’s divergence from Fed

The US central bank recently raised interest rates for the first time since 2018 and signalled more rate hikes in the coming months to tame rising inflation. The US consumer inflation rate skyrocketed to a four-year high of 7.9% in February, prompting the Fed to take a more hawkish stance despite the lingering COVID-19 pandemic and geopolitical uncertainties.

Conversely, the BOJ continued to loosen its monetary policy, reiterating that it would maintain interest rates at ultra-low levels to support Japan’s economic recovery and as inflation stays below its 2% target. The central bank also offered to purchase an unlimited amount of government bonds from Monday through Thursday this week at 0.25%.

The offer is for debts with maturities of more than five years and up to 10 years. The move is one of the BOJ’s attempts to contain rising bond yields despite US Treasury yields reaching new multi-year highs.

Adding pressure to the yen

The measure further weighed on the yen on Monday, with economists from ING Bank expecting upside risks to prevail beyond 125. They said "130 is well within reach in the near term unless the bond environment improves.”

A depreciation in the Japanese yen would drive up the costs of imports, ultimately hurting households as it would increase the costs of imported goods and other goods for consumption.

It also pushed Japan’s core inflation to a two-year high of 0.8% in March, quicker than market forecasts.

US and Japan inflation and interest rates

Preference for a weaker currency

While many economies beef up efforts to boost the value of their currencies, Japan has been aiming to devalue its currency to gain a competitive advantage in foreign trade. A weak yen will make Japan-made goods more competitive overseas and increase profits that Japanese companies make in foreign markets. It would also lift services exports and increase net income receipts from abroad when converted into yen.

Back in January, the BOJ estimated that a 10% drop in the yen would boost Japan’s gross domestic product by about 1%. In the final months of 2021, Japan’s GDP rose 4.6% year over year, lower than its previous forecast for a 5.4% rise. Fitch Ratings expects Japan’s inflation at 1.8% this year on the back of higher energy prices and yen depreciation.

Preventing another 1998 yen volatility

As the yen continues to fall against the greenback, the markets are closely watching for a recurrence of a wild rebound that occurred in the USDJPY in 1998 at the height of the Asian financial crisis. At the time, the US dollar fell by almost 15% versus the yen from its previous peak. That slump was preceded by a three-year yen depreciation as Japanese authorities believed the yen was overvalued.

Will the yen hit 150 against the greenback?

The question of whether the yen will reach 150 versus the US dollar is more of a when as the Fed maintains its hawkish stance and as the BOJ is poised to keep its loose monetary policy setting in the medium term. This would further widen the gap between their policies, sending the yen lower as Japan continues to book current account deficits due to a jump in oil import prices.

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USD/JPY Looking For 100?

We have seen a clear downtrend in the USD/JPY since the U.S peaked in early April. The Coronavirus saw a rush to the cash, specifically the Greenback.

However, with the financial markets roaring back to life since then, the love for the Greenback has faded. Furthermore, many Japanese investors bringing back their capital out of U.S stocks back into their home currency, the Japanese yen. This has pushed the pair lower, with it currently sitting at 106.

This contrasts with the countries' main stock index, the Nikkei 225, which has reached all-time highs touching 30,000. The last time it got close to 30,000 was in 1991, where the index touched 26,000.

If you held the Nikkei 225 from 1991 till the start of 2021, you would have been down 0.4%. In comparison, if you have held the S&P 500 from 1992 till the beginning of 2021, you would have been up around 1000%.

USD/JPY Playing Well In The Channel

USD/JPY downtrend has been following a consistent channel

We can see the USD/JPY adhering to this downwards channel diligently, with a breakout in around June. We are currently witnessing a breakout similar to that in June, and if history is a guideline for the future, we may see the pair retreat back into the channel, possibly hitting the 100 mark in the middle of March.

Japan – A Currency Manipulator?

Many Asian nations, including Japan, have been accused of manipulating their currency, specifically to the downside.

It is estimated that foreign exchange reserves held by 12 Asian nations total more than 6.5. Trillion dollars, up 500 billion to counter the effects of the Coronavirus. Asian countries buy up foreign currency using their own, flooding the market with a flush supply of their currency, pushing their currency's relative value lower. This benefits their exports, as it would be cheaper to purchase their goods in other countries – beneficial when your country is dependent on exports, and you are in the middle of a Pandemic.

This could be why there has been a steady downtrend in the U.S dollar against the Japanese Yen. We saw a steady rise from the start of 2020 in Japan's foreign currency reserves from 1.34 Trillion U.S Dollars to 1.4 Trillion U.S Dollars, an increase of 660 Billion U.S Dollars.

USD/JPY on a downtrend as safe haven strengthens

Volatility lies ahead as we head into the election season. One of the places investors and traders like to park their money is the iconic Safe Haven, the Japanese Yen.

USD/JPY on a downtrend

After the initial spike in the US dollar strength, the Japanese Yen strengthened against the US dollar by around 5.2%. Not as drastic as commodity pairs such as the Australian Dollar against the US dollar; however, the trend of the strengthening of the Yen has been consistent and strong.

Many banks see a strengthening in the Yen against the US dollar as we enter volatile times ahead. Bank of America's Global FX Team stated that they predict to see the USD/JPY pair at 103, citing the "reintroduction of COVID-19 measures in most countries, particularly in Europe". They further state that the Yen has gotten stronger during the recent periods of weakness in the stock markets.

US weakening providing tailwinds for the Yen

However, it's not just the Yen that is in the picture. Weakness in the US dollar may provide tailwinds for the Yen. Many large institutions such as Goldman, UBS, and Invesco predicting a weaker dollar, citing Biden extending his lead over President Donald Trump.

Japan has not been in the news much regarding their Coronavirus response. Similarly to Australia, they went with no lockdown opting for social distancing and face masks, trusting citizens to continue their life with the Coronavirus in mind. However, just like Australia, the method backfired. They experienced their second wave, which was larger than the first. They have since tamed the Virus, however, at a significant cost. The political risk of a sudden change in Prime Minister saw the Yen jump.

With elections coming up ahead, there is a high chance we see the Yen rally against the US dollar in the future.

Future of the US Dollar

As the Coronavirus started to wreak havoc across the world, the US dollar stepped up as the world's de-facto currency. Risk-off sentiment drove investors and traders to the US dollar in droves, pushing the US dollar to highs not seen since 2017.

US Dollar Index

The world's de-facto currency, making up over 60% of all known central banks' foreign exchange reserves, saw the FED offering swap lines to central banks to provide liquidity in the market by "swapping" their currency for US dollars. However, the dollar's strength may be short-lived as the market sentiment cautiously shift to risk-off assets.

Risk-off shown by demand for FX Swaps for the US Dollar

Thanks to the FED's swaps, demand for the US dollar across the world have been met, restoring equilibrium in the market. This was shown in a chart from Steven Englander of Standard Chartered Plc,

There may be more headwinds for the US dollar. As we all know, everything depends on the assumption on how we emerge from the Coronavirus pandemic. If we assume that we shall see an economic recovery with the markets discounting a second wave, we should see the USD depreciate back to pre-coronavirus levels. Furthermore, there are a couple of other factors that may help the dollar depreciate

Quantitative easing increases the supply of the US Dollar

Federal Reserve's balance sheet

With the Fed's balance sheet swelling up to $7 Trillion, they have been loosening their limits on what assets they are willing to purchase. They have recently added corporate bond ETFs to the lists of assets they are ready to buy. With quantitative easing and stimulus comes an increase in money supply, which historically has seen the currency in question to depreciate (See Euro and the ECB in 2015, Government Stimulus in the US in 2009, and Bank of Japan in 1997)

Low rates for a longer time

"We are not even thinking about raising rates", Jerome Powell stated at a conference earlier this month, showing that they are willing to provide accommodative financial conditions until 2022. This also means investors may want to see their money earn a return else wear where yields are relatively higher, especially in EM currencies.

Higher oil prices

Since oil transactions are denominated in US dollars, there is an inverse relationship with oil prices and the US dollar. Correctly, as oil prices increase, the pressure is put on the US dollar as producers convert more US dollars to their home currency.

If we see a promising recovery, there is a high likelihood we a sharp depreciation in the US currency. 

Yen Appreciates for Third Day

Despite a drop in the Nikkei 225, Japan’s stock index, the Japanese Yen has seen 3 straight days of gains now against the US Dollar. In contrast, the Nikkei dropped back below 18,000 points, a one week low.

Traditionally a very stable currency pair due to both currencies being strong safe havens, USD/JPY was steadily rising in the months leading up to March. However just like every other market, it was not safe from the extreme volatility brought on by the global coronavirus outbreak in March. After dropping all the way below 103, the Dollar eventually rebounded against the Yen to trade at ¥111 to the Dollar, influenced by the rise in strength of the greenback following a pullout from investors from assets back to liquid cash in order to minimise risk. It is currently trading at ¥107 against the greenback.

Investors are also looking towards the Yen once again as a safe haven, as it remains a strong currency in times of economic uncertainty, and this is certainly one of them.

However, the Yen's current status may be short-lived, amid growing sentiment that Tokyo may soon come under lockdown due to the sharp increase in coronavirus cases in the city. This new rise comes shortly after the 2020 Tokyo Olympic Games were announced to be postponed until Summer 2021, leading some to question whether or not the Japanese government had been suppressing figures in order to keep the Olympics going ahead.

The governor of Tokyo has urged citizens to avoid karaoke- the popular Japanese pastime- in order to maintain social distancing, despite warnings from senior health officials to put the city under lockdown before it is too late. Japan’s economy minister has warned that a lockdown of the country’s biggest cities would have disastrous effects on the Japanese economy. Prime Minister Shinzo Abe has also stated that a state of emergency is not yet needed, but that Japan could enter a situation like Europe very soon.

The Dollar also weakened once again following White House officials projecting that around 100,000 to 240,000 more deaths would occur in the United States due to the coronavirus. US President Donald Trump also gave warnings that the coronavirus would continue to worsen, backtracking on his statements from the previous week that he had expected to see the States reopen by Easter. However, he is still resisting calls to issue a nationwide warning to tell Americans to stay home. The Trump Administration’s lack of action has led to State governors to take action of their own. California and New York are continuing to be under lockdown, and an increasing number of states are also extending or adding their own stay at home orders.

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