What is behind the recent strength of the yen?

What is behind the recent strength of the yen?

September 23, 2020

A safe haven currency until recently, the yen has been one of the year’s best performers against the dollar. The USDJPY, once the symbol of a healthy stock market, has lost its mojo – the direct correlation with the Dow Jones or the S&P 500 has disappeared.

This is both a blessing and a curse. It is a blessing because we can now trade the exchange rate without having to consider what the U.S. stock market will do. On the other hand, it becomes difficult to predict its direction.


USDJPY – Fading Trump’s Policies

The easiest way to interpret the USDJPY and the decoupling of the stock markets is to remember the day of Trump’s election. Prior to the election, the two markets (i.e. the USDJPY and the U.S. stock market) moved hand in hand – when the Dow Jones fell, the USDJPY followed. Or, when the S&P 500 rose, the USDJPY followed.

Similar actions took place a few days after the election. The U.S. stock market experienced a massive rally, as did the USDJPY. It went from around 100 to 118, in an almost vertical movement, just like the stocks.

Then the JPY pair erased the movement of the stock market. Slowly but surely, over the next four years, it returned almost all of the gains, only to fall back to 104 recently.


Monetary policy differences have disappeared

One explanation for a strong yen is that differences in monetary policy have disappeared. Australia has rates close to zero, and the downward trend began well before the Fed’s late upward cycle began.

The ECB in Europe has had the deposit facility rate below zero for several years. So has the SNB in Switzerland. The Nordic countries in Europe have also had negative rates.

Suddenly, Japan was no longer the only country with zero interest rates. Moreover, quantitative easing (QE) is the norm in all developed countries. Thus, the yen has regained its flexibility, better reflecting its role among the fiduciary currencies.


Shinzo Abe’s Resignation Strengthened the Yen

Japan’s oldest Prime Minister, Shinzo Abe, has announced his resignation. The new government, led by Suga, is considered the third most popular government in the country’s history.

It has led to a sharp rise in the yen because the implications are that abomics is no longer popular. Or, at the heart of abomics was a weaker yen.

The interesting story told by the yen reflects how monetary policies around the world change the performance of a currency. Coupled with policy changes, money has an easier time decoupling itself from old correlations.

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