The Japanese Yen (JPY) is the 3rd most commonly traded currency in the world. It gives a very, very hard to see out turn relationship with domestic economic performance and international market sentiment. Analysts and economists alike are keeping a close eye on how the Bank of Japan’s monetary policies will affect the overall economy. This dynamic has been in the headlines these days. With the US-Japan trade agreement coming into effect in an orderly manner, the consequences for the Yen’s value could be quite substantial.
The value of the Japanese Yen is mostly determined by how well the Japanese economy is doing. We need economic indicators such as GDP growth rate, rate of employment, exports, etc. They are an important driving force for making investors take a positive view of Japan’s fiscal situation. Additionally, the Bank of Japan’s policies are instrumental in determining the Yen’s value. By maintaining an ultra-loose monetary policy, the Bank of Japan has contributed to a widening policy divergence with other central banks, particularly the US Federal Reserve.
The Impact of Bond Yields
In fact, the value of the Japanese Yen is now primarily determined by the gap between Japanese vs. US bond yields. This differential has a profound impact in determining currency trajectories. When bond yields in Japan lag behind those in the United States, it typically favors the US Dollar against the Yen. This differential produces a propulsion force on investment flows, with asset traders generally moving to invest where return is highest in US assets. By contrast, a closing of the yield gap would be bullish Yen. Investors are going to re-evaluate their risk and return calculus that will bring this support.
Additionally, markets are routinely reactionary, typically spiking up or down due to changes in bond yields in a hyper-sensitive manner, causing immediate impacts to currency values. It’s for this reason, perhaps, that recent trends have the US Federal Reserve signaling potential interest rate hikes. As a consequence, the spreads between 10-year US and Japanese bonds are widening, positively impacting the Dollar. Even more than usual, such movements are a testament to how tightly intertwined global financial markets are, and how much they can drive currency valuations.
Safe-Haven Status During Turbulent Times
During periods of heightened financial market volatility or macroeconomic turbulence, the Japanese Yen is often perceived as a safe-haven asset. Investors flock to currencies that are stable and widely reliable. This usually results in the Yen appreciating against the less stable currencies. This strange occurrence is a great example of how risk sentiment from traders impacts the strength of the Japanese Yen directly.
The BoJ’s continuing commitment to control the Yen’s currency direction will be tested as they try to stabilize the Yen and tread water through unprecedent global economic trouble. When tensions flare in geopolitical or financial markets, Yen becomes a safe haven asset–investors run to this currency at the first sign of trouble. As a result, Yen tends to appreciate in value, strengthening the currency against other, riskier currencies during uncertain times.
Future Outlook Amid Policy Changes
The Bank of Japan, long an outlier among central banks, is slowly unwinding its extreme ease. Recently this shift has started to buoy the Japanese Yen. As anticipation grows regarding possible reforms to these policies, stakeholders in the housing market have their eyes peeled for any indication of movement. Though a future tightening would increase the Yen’s attractiveness, the risks attached must be duly noted.
The recent easy implementation of the US-Japan bilateral trade agreement is one more bullish undercurrent for Japanese Yen. This treaty aims to deepen the strategic and economic ties between the two countries. In doing so, it could enhance trade flows and deliver more economic stability for Japan’s economy. As these relationships deepen, these will all contribute positively to investors’ confidence in holding Yen-denominated assets.