A fundamental analysis of the USD/JPY currency pair needs to start with a big picture, decade-long overview of the value of the Japanese yen. The 21st century malaise of essentially zero growth in Japan’s economy plus a culture of hoarding cash, even if it was earning zero interest, resulted in a 10-plus year period of steady strengthening of the yen. The 10-year USD/JPY chart shows the last 5-year leg of an ever stronger yen running from mid-2007 into most of 2012.
The naming for a second try of Prime Minister Shinzo Abe at the head of Japan’s government in December 2012 allowed the Abe to implement his policies of “Abenomics” consisting of fiscal stimulus and monetary easing. The implementation of Abe’s policies led to a bull market for Japanese stocks and a 22% weakening of the yen in Dollar terms – which shows as a higher rate for the USD/JPY currency pair. Forex traders who caught the Abenomics fever hit the trade of a decade. The yen went almost straight-line from 80 to 95 and took just a few side trips on its way to 102 in less than 6 months. Catching a 20 yen gain equals 2,000 pips in your trading account. However, that trade opportunity has passed, and the near future of USD/JPY depends primarily on what happens in the Japanese economy.
[tweetable alt=””]The implementation of Abe’s policies led to a bull market for Japanese stocks![/tweetable]
Positive Factors for a Weaker Yen and Higher USD/JPY
The primary benefit of a weaker yen will be higher profits for Japanese companies that manufacture in Japan and export. Selling abroad in foreign currencies, results in higher profit, in yen terms. Those higher profit reports lead to higher stock prices, which also should cause the yen to weaken. Better export profit numbers are a goal of the Abe administration and a primary reason why the Japanese government will promote policies to further weaken the currency.
Economic growth results that hit or exceed economist estimates and government targets will show that Abenomics is working and should continue to weaken the yen and push the yen to dollar exchange rate higher. The Japanese economy grew by 1.6 percent in 2013, but the rate slowed to just 0.3% in the fourth quarter. Stronger GDP growth reports should have an immediate impact to weaken the yen.
The recent slow growth numbers should push the government and Bank of Japan to continue and possibly accelerate monetary easing. Last year, the BOJ committed to pump about $600 billion into the economy. More of the same in 2014 is probably necessary to keep the USDJPY number moving significantly higher. Announcements from the BOJ concerning additional fiscal stimulus should cause yen weakness in the forex markets.
Factors That Would Point to a Stronger Yen and Lower USD/JPY Rate
While a weaker yen is good for exports, the same factor increases the costs of imports. As a result, the January trade deficit for Japan hit record numbers. Exports in January were up 9.5% compared to a year earlier, but imports jumped by 25%. The result was a 2.8 trillion yen trade deficit. The weaker yen over the past year makes imports more expensive at the same time exports become worth more in yen terms. Imports have a less favorable impact on the economic growth numbers that the Abe administration is looking for.
The Abenomics steps cannot fundamentally change the larger trends in the Japanese economy, including an aging, fiscally conservative population, employment policies that are counter to economic growth and a hoarding of cash by both individuals and businesses.
U.S. investors – both institutional and individual – own a large portion of the Japanese stock market capitalization. As a result, the value of the yen and Japan’s stock market are closely tied in an inverse relationship. If American investors lose faith in their Japanese stocks, selling those shares will drive down the stock market and strengthen the yen.
Fundamental Outlook for Three Months and Through 2014
If you watch the USD/JPY on a daily or weekly chart, you are well aware that the yen has settled into a 101.00 to 103.50 trading range. The factors noted above are equally balanced, preventing a breakout in either direction. I believe that the Japanese government is OK with the current value of the currency, but would like to see the yen weaken further, then resulting in a higher numerical exchange rate. If the yen starts to strengthen, expect the BOJ to jump in with more liquidity for the economy. View the psychologically significant 100 exchange rate as a floor, which if breached, government intervention is likely. A strong, rising Japanese stock market, and to a certain extent a strong U.S. stock market are positive for a weaker yen/higher exchange rate. For the next several months, these economic factors point to a higher yen rate. The USD/JPY bias will be upward depending on how close the rate is to the 100 level. As the exchange rate increases, the force of the bias decreases. I do not expect the yen to break the recent 105.37 high in the first half of 2014.
In May, the Japanese national sales tax rate is set to increase significantly. Like all governments, the one in Japan does not believe higher taxes will hurt the economy. With 60% of the Japanese economy based on consumer spending, I expect a significant slowdown in GDP for the country after the new tax rate goes into effect. Expanded government intervention will be necessary to continue to fuel GDP growth. The result on the yen will be a strengthening of the currency – lower USD/JPY rate – whenever bad news hits the wires through the release of Q2 GDP numbers. And most of the news will be bad for the next several quarters. However, the Abenomics policies should take hold with stronger growth by the end of the year. As a result, the USD/JPY declines due to bad news events will eventually be overcome by more sustained good news. Expect the USD/JPY to be somewhat higher by the end of 2014. In the 105 to 110 range!
This article was written by: Tim Plaehn
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