The U.S. dollar/Japanese yen pair features low bid-ask spreads and exceptional liquidity. As such, it is a great pair to trade for newcomers to the forex market as well as an old favorite for more experienced traders. Given the forex market's 24-hour trading day, U.S.-based traders who prefer to trade at night should consider focusing on the U.S. dollar/yen because the yen is heavily traded during Asian business hours. (For more insight, see In the forex market, how is the closing price of a currency pair determined?)

Trading the U.S. Dollar/Japanese Yen

Selling the yen as part of the carry trade is a popular strategy. The popularity of the yen carry trade depends greatly on the state of global financial markets. Interest rates set by central banks around the globe have all moved near zero in recent years; thus, the interest in the yen as the funding currency in the carry trade is significantly lower than it has been historically. Also, opportunities have existed in global financial markets while volatility has been relatively low; traders considered the yen carry trade to be lucrative. However, when volatility increased, the yen carry trade tended to decline in popularity. A good thing for forex traders to look for when unsure of global volatility is the popularity of the yen carry trade among hedge funds and other institutional investors. During relatively quiet periods, the carry trade is popular, and the ensuing selling pressure will typically cause the yen to weaken. When global market volatility increases, the popularity of the yen carry trade diminishes. As traders reverse the carry trade, they must then purchase the yen. This buying pressure leads to a general appreciation in the yen relative to the U.S. dollar or other currencies.

Another factor to consider concerning the yen is Japan's dependence on trade. Since Japan is largely dependent on imported oil and other natural resources, rising commodity prices tend to hurt the Japanese economy and cause the yen to depreciate. Slower economic growth among Japan's major trading partners will also cause Japan's export-dependent economy and the yen to weaken. Japan's export dependence can lead to central bank intervention when the yen is strong. Although economists sometimes debate the effectiveness of central bank intervention, it's important to consider its impact. The Bank of Japan has a reputation for intervening in the forex market when movements in the yen might threaten Japanese exports or economic growth. Forex traders should be conscious of this so that they are not caught by surprise if intervention by the Bank of Japan causes a change in the trend of the yen. (For related reading, see Using Currency Correlations To Your Advantage.)

As the most liquid currency in Asia, the Japanese yen is also used as a proxy for the overall Asian economic growth. When economic or financial volatility hits Asia, traders react by buying or selling the yen as a substitute for other Asian nations whose currencies are tougher to trade.

Finally, Japan has suffered an extremely long period of poor economic growth and correspondingly low interest rates. Traders should monitor the future path of Japanese economic growth and recovery. A future rise in rates could bring a decrease in the popularity of the yen carry trade and consistently stronger levels for the Japanese yen.

Japanese Yen Fast Facts

The Japanese economy is the leading economy in Asia and the world's third-largest national economy [1]. Japan is a major exporter throughout the world. Because of Japan's considerable trade with the United States, Europe, Asia and other nations, multinational corporations have a frequent need to convert local currency into Japanese yen and vice versa. Consistently low interest rates in Japan have made the yen a popular currency for the carry trade also. For these reasons, among others, the U.S. dollar/Japanese yen pair is heavily traded in the forex market. 

The Japanese Economy

As a relatively small country with little in the way of natural resources, Japan has relied on new technologies, a strong work ethic, innovative manufacturing techniques, a high national savings rate and a close working partnership between the Japanese government and business sectors to overcome its natural disadvantages. Although the country and its economy were severely damaged during the Second World War, the Japanese economy has since grown to become one of the largest in the world next to the United States and China. 

However, following 40 years of incredible economic growth, the early 1990s marked an end to the Japanese bull markets in domestic equities and real estate. The bursting of these bubbles led to a quick economic slowdown and a deflationary spiral. The Japanese banking system was left with trillions of yen in bad loans and, consequently, cut back its lending activities. Japanese consumer spending also slowed dramatically as the country entered a prolonged economic downturn. For two decades, the Japanese government has struggled to revive the economy and return growth to its previously robust rates. Although efforts have not yet been completely successful, no one argues the fact that Japan has become an economic powerhouse and an important source of global economic activity today. (For more information, see The Lost Decade: Lessons From Japan's Real Estate Crisis and Crashes: The Asian Crisis.)

The Japanese Yen

The Japanese yen is the most heavily traded currency in Asia and the third most actively traded currency in the world behind the U.S. dollar and the euro [2]. During the 1980s, some analysts thought that the yen would one day join the U.S. dollar as one of the world's reserve currencies. Japan's extended economic decline destroyed those hopes, at least temporarily, but the yen remains an extremely important currency in the global financial markets. (Find out how yen carry trades contributed to the credit crisis; read: The Credit Crisis And The Carry Trade.)

The primary outcome of Japan's extended period of sluggish economic expansion is that the Japanese central bank has been forced to keep its interest rates very low to encourage economic growth. These reduced interest rates have made the Japanese yen extremely popular in the carry trade. In a carry trade, investors and speculators sell the yen and use the proceeds to purchase higher yielding currencies. This constant selling of the yen has played a part in keeping it a lower level than the level at which it might otherwise trade. 

[1] http://statisticstimes.com/economy/projected-world-gdp-ranking.php

[2] https://www.finder.com/ca/the-japanese-yen

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