The Japanese yen has been one of the worst performers in G10 FX since the election. Analyst calls for USD/JPY at 100 by 2017 seem a far cry from current investor sentiment. The yen has been a favorite in expressing recent USD strength, driven largely by the anticipation of more aggressive rate hikes from the Federal Reserve. But that very same dynamic is also the one that injects hope into the bleak landscape before JPY.
Gold and the Yen
Gold and the yen often trade in tandem, a correlation stemming from their mutual enjoyment as safe havens from global risk. Both are readily used as an alternative investment when U.S. economic prospects are deficient and global risks weigh in. As we’ve seen in recent weeks, newfound optimism for U.S. economic prospects have driven widespread JPY depreciation.
However, this correlation seems tenuous when recognizing that there is no economic basis keeping gold and the yen aligned. The two assets are fundamentally different in their composition and macro influences. So, while a bullish sentiment for the U.S. traditionally drives funds away from both assets, the yen’s underlying dynamics paints a more complex profile that could cause the two to diverge.
Due to its low yield and relative stability, the Japanese yen is often used as a funding currency for carry trades. When these trades unwind, money flows back into the funding currency, making the yen an attractive proxy for EM worries and promising a degree of resilience much like we saw in early 2016. Despite further easing of monetary policy at the start of the year, JPY was bolstered by rapidly unwinding carry trade in what was a hectic year for emerging markets. The EM outlook is far more precarious since the U.S. presidential election. Last week marked the sixth consecutive week of outflows from EM bonds. Some analysts expect similar volatility in 2017; not least of all a Trump presidency which has investors expecting a more hawkish Fed. When the Fed cut rates aggressively in previous periods, investment flowed into EM assets. Conversely, a Fed that is now expected to quicken the pace of rate rises could affect the opposite, moving money out of these risky assets and back into their funding currencies such as the yen.
BoJ and the economy
A markedly weaker yen may be just what the doctor ordered for the Japanese economy, an early Christmas for the Bank of Japan. A weaker yen can drive growth and inflation, underpinning Japan’s economic outlook and largely supplanting the need for action from the BoJ which has struggled to support these targets. The bank’s heavy-handed monetary easing has been largely ineffective, so perhaps currency weakness is the solution.
Persistent weakness in the Japanese economy and a stronger fundamental outlook for the U.S. supports bullish calls for USD/JPY in the near-term outlook. However, prolonged dollar strength could improve Japan’s underlying macroeconomic data and help the BoJ achieve its targets without further easing.
Natalie Ciavarella is a corporate dealer for World First USA, Inc.
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