The Yen depreciated about 13% versus the US Dollar between 5th January 2021 (a 9-month high) – and 4th January 2022 (a 4-year low) but has since rebounded about 0.7%.
The Yen Nominal Effective Exchange Rate (NEER), which provides a more accurate overall picture of Japan’s currency and trade competitiveness and of the risks of imported inflation/deflation, has appreciated about 1%.
What has been weakening the JPY?
Yen weakness in the past year has been partly due to deterioration in Japan’s goods trade deficit to a still modest 1.2% of GDP in September-November. The Yen-value of exports has risen rapidly in the past 18 months but imports have increased even more rapidly and from a higher base due to a modest rebound in consumer demand and increased import costs.
“Going forward, we expect the trade deficit to stabilise, with new social distancing restrictions negating loose fiscal policy’s stimulative impact on consumption and imports,” said Olivier Desbarres, founder of 4X Global Research. “Domestic labour supply shortages – accentuated by self-isolation rules – and ongoing supply-side shortages are likely to dent Japan’s ability to fully capitalise on a competitive Yen and any material pick-up in imports, including from Europe, in our view.”
The “safe-haven” Yen also weakened in the 12 months to early January due to capital outflows – the sale of low-yielding Japanese assets – driven by buoyant global risk appetite, Desbarres explained.
Inverse correlation with the S&P 500
The Yen NEER has been strongly inversely correlated with the S&P 500 and has benefited from the near 10% collapse in the equity index since 4th January. However, the common perception that the Yen has been used to fund long emerging market currency positions has not held true since mid-2020 with both tending to move in tandem.
The Yen NEER has historically only exhibited modest monthly seasonality, even in its weakest months (November and December) and strongest months (June and August).
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“Our core near-term scenario, premised on equities correcting lower, is of modest Yen NEER appreciation, its pace capped by our expectation that Japan will continue to run a trade deficit in coming months,” Desbarres added. “Moreover, monthly seasonality has historically been negligible in the month of February.”
JPY broke crucial support level in January
The Yen broke through what was considered a crucial support level earlier this month, hitting a 50 year low against the currencies of Japan’s most important trading partners. JPMorgan Chase has cautioned that if the Yen continues its sharp depreciation this year, it could trigger long-predicted capital flight by Japanese households. At this stage, verbal intervention by the Japanese authorities and even a surprise rise in Japanese inflation would not be enough to stop a further slide in the JPY.
Traders should note the contribution of China’s renminbi as part of the JPY trade-weighted index. Because of the rising volume of trade between China and Japan, the RMB has a bigger share of the JPMorgan index than the USD. The JPY is typically more sensitive to the RMB’s appreciation than it was historically.
Trading floors have been reporting that non-Japanese investors have been building large short positions on JPY in December and January. This is also a popular proxy for a bet on higher US interest rates.