What Drives USD/JPY?
The USD/JPY cross, commonly known as the "gopher," is one of the most traded currency pairs on the market.
A currency pair is effectively a trade that compares one's confidence in the strength of one economy to that of another. So we need to look at the relative strengths of the US and Japanese economies.
The US economy continues to be one of the best performing economies in the West, consistently beating Japan by around 2% on average over the last ten years. Japan’s growth rate remains broadly in the 0-2% range, and the US's in the 2-4% range (excluding 2008).
Population Growth and Aging
Japan's ratio of working-age to dependent population is among the worst in the developed world, and is only set to get worse. This is a problem across the developed world, but particularly acute for Japan and much less so for America. Simply put, this means that there aren’t enough people to make things in the economy to make it grow. America, on the other had has a more favourable economy with a better ratio of working-age people to dependents. This means that America should have a better chance of making more stuff in the long run and therefore performing better economically.
Divergent Monetary Policy
Simply put, America is looking to raise interest rates, Japan is not.
Japan currently has its lowest-ever interest rate at -0.1%. It has no immediate plans to increase the interest rate in the near future, and if it did, the move would be modest.
America, after a long period of low interest rates, is now looking to gradually increase rates. The rate moved from effectively zero to now above 0.25% with further increases anticipated.
Quantative Easing (QE)
Following the 2008 crash, the US entered a long period of quantitative easing (QE). By printing money it devalued the dollar to make exports more competitive. As the US programme wound down, Japan, enacting Shinzo Abe’s policies, known as Abenomics, started its own large QE programme. As with all QE programmes the aim was to free up money and make Japan’s exports more competitive. This was reflected in a large rise in the value of the dollar against the yen since 2012. Japan’s QE programme has since finished; Japan have stated that they would be prepared to start again to generate stimulus.
So the macro data suggest that the dollar should rise against the yen in the longer term.
There are some other factors to consider.
USD/JPY and S&P500 Correlation
USD/JPY tracks the S&P 500
The S&P 500 index is very closely correlated to the USD/JPY. Therefore signs of weakness or strength in one can help to predict it in the other. This chart demonstrates that correlation during 2012-13.
Other factors to consider
The Yen’s role as a Safe Haven
When there is panic in the market, money will often flow into the yen. The yen has a historical role as a safe haven in times of trouble. So when stock markets, particularly Asian stock markets, crash, the yen will rise. Whilst the dollar is also a safe haven currency, the Yen is generally slightly more favoured than the dollar.
The Trump Factor
We cannot ignore the potential volatility that Trump’s presidency might cause. If he is good for American business, then we can expect to see the dollar rise. But if he brings instability to Asia, through changing trading relationships with China for example, this could cause a flight to safe-haven currencies like the yen.
How would you trade
Which way would you trade the USDJPY?
Long Term View of the Price
In recent years, there has been a significant increase in the value of the dollar against the yen: almost 50% since 2010. Many think the bull run has ended.
However if we consider the macroeconomic climate of a bullish US and stagnant Japan, and place that against a longer term chart, as shown below looking at the last 40 years, we can see there is plenty of scope for the pair to move up. A move up to 150 would still be moderate compared to the longer term view.
The Gopher Over the Last 40 Years
Trading and Investing is an uncertain business. But the data and outlook suggest that the highest probability trade is to buy the USD against the Yen. It may be best to wait for a market wobble to get a better price, but the general trend should be upwards.