Baris Özer
That sounds like a contradictory title, and it is. A weak economy compared to that of another country should drive a currency lower. Still, the yen has been in a steady bullish trend against the US dollar since it hit its recent rate Low at 151.944 on Oct 21, 2022.
So, will this uptrend for the yen continue? Or will the Japanese currency return to its long-term bear trend? Nonetheless, this could still be a good time to buy the Invesco CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY) and catch the yen rally if it continues. Let’s further examine the factors driving the yen’s reversal and appreciation trend.
If we look at GDP growth in Japan and the United States, we can see how the US economy has outperformed the Japanese economy. The last data we have for GDP growth in Japan showed a quarter-on-quarter decline of 0.2% for Q3 2022.
While GDP growth for the same quarter in the US was a positive 3.2%, the US recorded a 2.9% increase in Q1 2023 GDP. And at the time of writing, expectations for the next Q1 2023 GDP growth in Japan are 0.5%.
This figure for GDP in Japan would close the gap between the two economies. However, there is still a 2.4% margin of GDP growth in favor of the US. Hardly would I say a single reason for the yen’s bullish move. So it has to come from somewhere else.
Interest charges
Central bank interest rates are still negative, despite the BoJ’s recent move to allow 10-year bond yields a wider range of 0.50% above or below zero, from the previous range of 0.25% above or below zero , which helped the yen gather momentum.
Still, the spread in bond and Treasury yields between the two countries is extremely wide and in favor of US equities.
Worldgovernmentbonds.com
The chart above shows the US yield curve from 1-month T-bills to 30-year bonds. The chart below shows the same curve for Japanese stocks. We can see that the US yield curve is 5.044% higher than the Japanese yield curve for 6-month T-bills and 2.118% higher for 30-year bonds.
Worldgovernmentbonds.com
The wide range in government bond yields is an important driver of exchange rates. However, despite the large positive bias for US assets, the FX market may have pushed this currency pair too far. What we may be seeing now is a retracement and consolidation to levels more consistent with fundamentals.
purchase price parity
This is a concept that tends to apply to many currency pairs of two countries with similar economies. Similar in the sense of how evolved they are. Japan and the United States are certainly in the league of the most developed countries.
So, in theory, the same products should cost about the same in both countries, taking into account the exchange rate. However, differences can persist over time for a variety of reasons. Still, it seems obvious to me that goods in one country should have similar prices in the other.
This metric tends to change over long periods of time as other factors eventually bring Purchase Price Parity (PPP) into line. Also known as the Big Mac Index, literally because the shopping cart used to determine the PPP Index can be simplified by using McDonald’s Big Mac as a proxy.
So if we look at the average price of a Big Mac in the US and compare it to the price of the same burger in Japan, we can get an idea of how expensive the burger is in one country compared to another.
Or in other words, how overvalued one currency can be compared to another when it comes to buying fast food. The USDJPY exchange rate resulting from the two prices below is ¥87.04. I think this is far fetched for anyone seriously considering the possibility of USDJPY reaching this level any time soon.
MC Donalds
MC Donalds
However, it does tell us that the Big Mac is extremely expensive in the US for a Japanese buyer considering the exchange rate. The US Big Mac would cost ¥677 at the current exchange rate of 131.00.
While the Big Mac is extremely cheap for an American shopper who would buy the burger for $3.44. This price differential indicates that the PPP is out of control and the dollar is overvalued relative to the purchasing power of the US dollar exchanged for yen.
Doesn’t that factor alone justify the yen’s rally over the past few months at all? However, it suggests that the PPP has gotten out of hand and should eventually return to more neutral levels even if parity is not met.
Technical view
USDJPY medium-term chart with monthly candlesticks shows an ongoing uptrend that started back in January 2021 after hitting a low of 102.59. However, the January 2023 market has already printed a small-bodied candle.
This indicates sideways movement and the current candle, while still early, could print something similar. For now, the Ichimoku system shows that an uptrend is still intact. However, the first sign of weakness is coming from the RSI, which broke below 70, and its moving average, and it looks like it may continue lower.
trading view
It would be several months before USDJPY’s long-term uptrend showed any signs of reversal. But it looks like the retracement may continue from its October 2022 high to levels near or near the cloud.
The medium-term chart below shows how the recent price retracement has found support in the cloud over the past 4 weeks. The cloud only acts as a support when price moves away from the cloud after touching or trading into it. Only then do we know that the support level was valid.
trading view
At the moment the market is still close and almost in the cloud. We would need to see the next few candles quickly move away from the cloud to indicate fresh bullish momentum for the US Dollar. Another indication of momentum weakness comes from the RSI.
The RSI below its moving average and well below 50 suggests that further downside momentum may be imminent. The next level of support is on the lower side of the cloud around area 128.
trading view
From the daily chart above, we can see a clear short-term bear trend with price action below the cloud. The moving averages are bearish and the forward cloud is red, completing the picture.
The RSI has just moved above 50 and its moving average, which could lead to further price action higher. However, the overall short-term picture is bearish for USDJPY.
central banks
The next BoJ monetary policy meeting is on March 9th, while the next FOMC meeting is not until March 31st. The BoJ is not expected to touch interest rates or take any further action on bond yield ranges.
However, I believe that when they meet in December 2022, they feel that they have done enough for now. Since the day of that meeting, the yen has appreciated 4.2% from 136.91 to 131.20.
At their January meeting, they maintained their current stance on easing and agreed to continue steering the yield curve. From the minutes of the January meeting, I find this point instructive:
“Given the development of economic activity and prices, it is appropriate for the bank to continue the current monetary easing, including the implementation of yield curve control.”
As far as I know, more action will be taken in the future to allow bond yields to rise. At some point I assume they would also be obligated to turn central bank interest rates positive again.
The rise in domestic asset yields could have a dramatic impact on the USD/JPY exchange rate. The more Japanese investors find domestic securities more attractive as yields rise. This would create further downward pressure on the USDPY exchange rate.
Diploma
I think the yen will continue to appreciate as the BoJ lags far behind the Fed in tightening policy. Not only that, the Fed will increase the Fed Fund’s interest rate in smaller increments and is expected to stop doing so by June 2023.
This leads to a scissor effect in interest rate differentials and bond yield spreads. I would expect a large capital shift back into the yen and away from the US dollar. However, that doesn’t mean USDJPY is in free fall lower.
I can expect some recovery in the exchange rate, but in the medium term I see the yen on the rise again. I see FXY ETF as a mid- to long-term buy, although the timing may not be the best right now.
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