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What is Driving USD/JPY Higher?

Last updated 2/27/2009 9:44 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

Since the beginning of the month, the US dollar has skyrocketed against the Japanese Yen. The strength of the currency pair has baffled nearly all forex traders. For the past 12 months, USD/JPY has traded in lockstep with US equities, but as the Dow Jones Industrial Average hits a 12 year low, USD/JPY has soared to a 3 month high.   The correlation that once provided currency traders with a reliable explanation for day to day price action is only adding to the confusion.  Risk aversion was the predominant theme in the financial markets this past week and yet USD/JPY, “the” barometer of risk is rising and not falling. 

The surprising weakness of the Japanese Yen has been attributed to investors finally waking up to the problems in the Japanese economy. Based upon the fact that Japan is running its largest trade deficit in 28 years and 2 interesting correlations identified by UBS and Deutsche Bank, fundamentals may be mattering to the Japanese Yen once again. 

The following chart illustrates the deterioration in Japanese trade. As of January, the trade deficit has reached Y952.6 billion. The country which has historically run a trade surplus has faltered on the back of the financial crisis. The irony is that the country was not widely implicated in the holding of the toxic assets that destroyed years of financial progress. Instead, their dependence on the health of the rest of the world has brought them to their knees. Trade has been battered from two lethal angles. First, the financial meltdown nearly evaporated international demand for Japanese imports. Durable items such as cars and computer components were the worst hit. Secondly, as investors clambered into yen denominated assets, the currency was set on a historical rally versus all other major currencies. The deficit has only added on to the poor economic news, highlighted by a more than 12.00% decline in GDP.

The trade balance is extremely important to Japan because on the most fundamental level, currencies move based upon demand for imports and exports. UBS put together this great chart illustrating changes in the JPY over a 12 month basis and the average rolling trade surplus for Japan over the same period.  As you can see, the relationship is strong with the Yen beginning to fall against the dollar as the trade surplus turns into a deficit.

Deutsche Bank on the other hand highlights the relationship of USD/JPY and the 2 year US and Japanese interest rate spread. The spread has recently turned higher, coinciding with the rally in USD/JPY.

Based upon these charts, if the relationships hold, we could see the Japanese Yen fall a lot further with USD/JPY hitting 100.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.