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The Future Path of Dollar-Yen: Drivers of USDJPY in 2018

Posted on: 23 January 2018 , by: Darren Sinden , category: Market Review

The future path of Dollar-Yen is something of a conundrum and perhaps more so than any of the other FX majors. That's because there is a genuine two-way pull on the Yen, and it's not clear which of these contradictory forces will emerge victorious, if either.

In this article will look at both the fundamental and technical drivers of the Yen, and by extension the Dollar-Yen rate. But given the broadly sideways movement in the price action seen since mid-September, the bias in this article will be towards the fundamentals.

Fundamental Factors

We explored the fundamental drivers of the Japanese Yen in our 17th of August Analyst Insight article: The Yen paradox. Much of what we wrote then is still applicable today.

A Deeper Look Into Japan’s GDP Growth

Though there have also been changes on the ground, over the last five months, that we need to take notice of. Perhaps the most important of all of these is the continued rebound in the Japanese economy, as measured by the growth in its GDP. In fact, Japan has posted seven straight quarters of growth based on this measure. The best winning streak since the year 2000 and enough to suggest to many commentators (including myself), that the stagnant Japanese economy is finally turning a corner, after decades of virtual stagnation. We should note however, that the economy has promised much but failed to deliver, on several occasions over the last 17 years. As we can see from the chart of quarterly GDP growth over that period, below.

Japan GDP Growth Rate

Based on that history, it may take a couple more positive quarters of growth before the whole market falls in behind the sustained recovery meme. Though if we look at both the real and nominal rates of annual GDP growth in Japan, we find that they have both been rising.

Real Vs. Nominal GDP

The rebound in the Japanese economy would seem to have been export led, and we can see the pickup in the value of goods and services sold overseas in the chart below.

The table below that, shows the most active export sectors in the Japanese economy during 2016.


Export Sectors in Japan

The top ten export sectors by value in Japan during 2016.

Top 10 Export Sectors in Japan

Despite spikes in the mid-1990s and again in the aftermath of the 2008 GFC, inflation has been trending lower. But interestingly it bottomed out in 2016, and over 2017 it has started to pick up once more. Our second chart (below) shows the Gold price (in red) versus expectations about future rates of inflation in the USA (in blue) since January 2015. 

To some extent, these numbers vindicate PM Shinzo Abe's three arrows policy, one tenant of which was to create growth in exports via a weaker Yen. And here we come up against the Yen paradox once more. What I mean here is that we have seen export growth and an economic rebound in 2017 but there’s surprisingly been no Yen weakness. The currency has been anchored in a range between 111 and 115 Yen to the Dollar, over the last quarter of 2017 and into the New Year. This, despite the largely uncontested re-election of Premier Shinzo Abe in October, and no material change in monetary policy from the Bank of Japan. 

This might be an appropriate juncture to remind readers of the risk barometer status of the Yen. The Yen is a safe haven currency, and money has historically flowed into it during times of crisis or perceived market stress, and the Yen typically strengthens as a result. Conversely when markets are "risk on" the Yen, with its low-interest rates, often acts as a funding currency for so-called carry trades. Whereby investors borrow in Yen and then sell those Yen to fund the purchase of other higher-yielding assets. Under those circumstances, the Yen should weaken. 

One measure of risk on/risk off sentiment is the VIX index. Effectively this is a measure of investor greed and fear. The higher the VIX index, the more risk averse the market is said to be. The VIX printed 18 of it's 20 all-time lowest closes during 2017, so we can certainly view the markets as being risk off. Yet the Yen has failed to weaken appreciably.

Japan’s Consumer Confidence, Household Spending and Population

Having looked at matters external, we should now look at the domestic economy, which may hold the key for both the overall Japanese economy and the future direction of the Yen.

Japanese Household Spending vs Consumer Confidence

Both consumer confidence and household spending have been picking up in Japan lately, and of course, unemployment runs at around 2.7%. A rate that is the envy of the developed world and only topped by Singapore's 2.20%. Unfortunately, job vacancies are continuing to rise and as of November, they stood at 988,000. The chart below shows job vacancies against the change in Japan’s population. The truth is there just aren't enough Japanese people of working age to fill the vacancies, and though the population decline seems to have bottomed out in the last couple of years, Japan faces genuine issues here. As it does not have a history of large-scale immigration with which to plug the shortfall. For example, in 2015 there were less than 10,000 applications for Japanese citizenship from foreign nationals in the country.

Japan's Job Vacancies vs Japan Population

The population is ageing rapidly, and it has one of the worlds longest life expectancies.

All of these demographic factors will continue to weigh on the domestic economy and hinder a quicker recovery therein, unless they are addressed sooner rather than later. 


Technical Outlook

As we noted above, Dollar-Yen has effectively been range bound over the last four months. 

As such, the price action in the pair fits nicely into a Fibonacci retracement that is measured from the high, posted on the 11/12/2016. As you can see below, Dollar Yen found support around the 38.2% retracement line, circa 107.98. 113.90 (not a Fibonacci level on this screen) has provided resistance with 114.78, which is the next resistance level above that. The pair is mid range as far as the RSI 14 indicator is concerned, with a current reading of 53. So there are few clues here.

USDJPY Weekly Chart

What is interesting however, is that Dollar Yen appears as a strong bull trend in my medium term model. This is a longstanding trend, and it's one of three that crop up among the Yen Crosses. The others being against the Euro and Sterling. For the avoidance of doubt in this context a bull trend implies Yen weakness, i.e. a higher value for the Yen exchange rate. The bull trend in Dollar-Yen would only be broken if we saw a move to or through 106 Yen to the Dollar, something that we haven't experienced since early November 2016. 

Lastly, the trade weighted Yen has been falling in value of late. Which in turn suggests that the Yen should weaken further outright against the US dollar. Of course, we can't ignore the fact that the trade weighted Dollar has itself been falling for much of the last year, and until Dollar index finds some stability and the means to rally, I think it’s likely that we may see Dollar Yen trade within its current range, disappointing as that may be to hear.


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