The Japanese yen has rallied 7% against the U.S. dollar, from a high of almost ¥113 to just its lowest level since November 2016, when the buck shot up following the result of the U.S. presidential election. But the yen rally could be far from over, said Ashraf Laidi, head trader and strategist at InterMarket Strategy.
For the past weeks, the dollar-yen pair USDJPY, -0.52% has been trailing a 16-month low, inching lower steadily. The global stock-market volatility that governed much of February led to a lot of yen buying as the currency is considered a haven asset, and a good store of value in times of uncertainty thanks to its liquidity.
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Also, Japanese investors investing abroad, tend to unwind their positions and bring cash home during downturns, which supports the yen’s exchange rate versus the greenback.
This week, market participants had to digest not just a selloff in equities, but also new fears over potential trade wars, as President Donald Trump announced new tariffs against China. The People’s Republic said it would retaliate.
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The dollar USDJPY, -0.52% last bought ¥104.73, versus ¥105.98 late last week Friday, marking a fresh 52-week high, according to WSJ Market Data Group.
And the reasons why the yen could strengthen further are manifold, Laidi wrote in a recent blog post.
For one, Japanese pension funds and insurers, who are “known for hedging their holdings of foreign assets against the risk of yen strength, […] have tilted their hedge ratios higher against the risk of their foreign earnings depreciating in yen terms” said Laidi.
And an increase in these yen hedge ratios further supports the Japanese currency, he added.
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Other reasons relate to Japan’s relatively high current-account surplus, the Bank of Japan’s bond purchasing program, recently improved inflation figures and a “higher upside for policy tightening than most other nations,” Laidi said. A current-account measures trade in goods, services, tourism and investment. It is calculated by determining the difference between Japan’s income from foreign sources against payments on foreign obligations and excludes net capital investment.
BOJ officials recently said that improving consumer-price inflation would naturally lead to a rolling back of the central bank’s ultraloose monetary policy. A hawkish central bank tends to drive the value of a currency up.
This isn’t necessarily welcome in Japan, as its own equity market has been fragile in the year-to-date and a stronger currency could lead losses to accelerate.
But to discern whether the yen is really strengthening at this point, as opposed to it just reacting to a weakening dollar, one has to look more closely: for example at the yen’s trade-weighted index, Laidi said (see chart below).
While the dollar-yen pair moved 11% since the beginning of 2017, the yen on a trade-weighted basis only rose 3%.
This disparity highlights that any the success of currency intervention from Japan officials should be limited, given the tide is pointing to yen strength by virtue of a weaker buck.
“Any rebounds in the dollar-yen pair resulting from interventionist remarks by the Japanese and U.S. officials are considered as a selling opportunity in the pair,” Laidi said. “Anticipating ¥105 on a trade-weighted basis would make ¥101 [versus the dollar] a preliminary stop before subsequently reaching ¥100.”