The USDJPY pair used to be one of the most popular carry trades, but its significance has diminished due to the decreasing interest rates in the U.S. Today the yen is significantly more valuable than its historic average of the past ten years.
The below live USDJPY chart shows the current market action in the pair. In the following sections we’ll discuss a brief summary of the Japanese currency’s history, followed by some recommendations on trading the pair.
USD stands for the American Dollar, while JPY signifies the Japanese Yen.
The US Dollar
The US dollar is the global reserve currency, the dollar market is the international medium of trade, and the world’s financial system is created on a dollar basis. Created in 1792, the US dollar has been the sole legal tender in America since 1857.
Although boasting the largest economy with the most liberal and free structure among the major nations of the world, the U.S. is suffering from a high level of national debt, ongoing wars in different countries, a significant (albeit diminishing) current account deficit, a prostrate financial sector, and a nervous market unsure about the length of its future dominance. At the moment, however, the dollar remains by far the most important currency in the world.
The Japanese Yen
The Japanese Yen (pronounced en in Japanese), has its roots in the Chinese imperial coinage. The Chinese system was imported by Japan during the early interactions between the two nations. The modern decimal monetary system was first formulated during the Meiji modernization process, however, in an Act issued in 1871.
The yen has been an undervalued currency during much of its history in the post-WWII period. As Japan rapidly industrialized to catch up with the West, the lower quality of Japanese goods was partly compensated by higher affordability, which resulted in a gradually increasing Japanese current account surplus. Since the yen was fixed to 360 yen =1 USD in 1949, this current account surplus placed increased tension on the peg, and the turmoil ensuing from the U.S. abandonment of the gold standard finally forced Japan to float the currency in 1973. The floating regime was highly controlled however, and the Japanese government continued to keep the yen at artificially low values for much of the period between 1973 and 1985. The price fluctuated between 240 and 300 yen per dollar during much of this period, sustaining and fuelling an ongoing bubble in Japan at the same time. When the low yen policy was partially abandoned as part of the Plaza Accord of 1985, the yen experienced a powerful rise in value (up to 128 per dollar) which is thought to have precipitated the collapse of the Japanese bubble, and the ensuing low-interest rate era which forced central bank rates to stabilize at their present extreme levels.
Trading the USDJPY pair
The USDJPY pair used to be the perfect pair of the carry trade, and also functioned as its barometer, plunging at times of heightened risk aversion, and rising rapidly when traders were optimistic about the future. This is still the case, but the carry potential of USDJPY, is much lower than what it was during the first quarter of 2008, for instance. Instead, 2009 has seen the yen continue to rally against the dollar as a result of ever diminishing and disappearing rate differentials, terrible performance in the U.S. economy (although Japan has arguably performed even worse), and the relatively light escape of Japan’s financial sector from the worst calamities of the crisis.
Although the new government has promised the electorate a different policy towards a stronger and more assertive Japan, with more independent foreign policy and greater liberalization in economic matters, the powerful intersection of American and Japanese interests, as well as the crucial role of the export sector in the Japanese economy have so far prevented any radical change of policy. Since the present period is one of storm and confusion in politics, establishing long-term trades in USDJPY may not be the optimal strategy.
The Bank of Japan used to intervene regularly in the currency markets to discourage traders from appreciating the yen too much, but the advent of the carry trader has allowed the institution to leave this task to market participants for the greatest part, and although warnings about the carry trade were frequently voiced, no serious action was ever taken. Today interventions are more and more difficult due to U.S. pressure on Japan to set out a model for China to follow as it abandons the currency peg.
Trading the USDJPY pair on a short term basis involves the usual strategies and caveats that would be valid in any other pair. Caution must be taken that traders do not get caught in periods of excessive volatility.
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