Safe harbor yen?

August 27, 2015 01:00 PM

For millennia, sailors have sought to read the signals in the environment, leaving their ships safely in harbor if they felt the possibility of a typhoon was too great to risk venturing out. In a similar vein, forex traders are constantly monitoring the global market environment for signs that a financial storm is more likely, parking their capital in “safe harbor” currencies like the Japanese yen when they judge that the risk of loss is elevated.

Throughout June and early July, a collapsing equity market in China and concern about a possible “Grexit” (Greek exit from the Eurozone) created threatening financial storm clouds for forex traders. Fear that these isolated disturbances could expand into a global financial hurricane prompted traders to buy the yen en masse, putting the brakes on the long-term USD/JPY uptrend. Thanks to several marathon negotiating sessions in Greece and an unprecedented policy response in China, though, traders are finally starting to see the sun peeking through these two big storm clouds. As these sources of risk fade, USD/JPY could soon resume its longer-term uptrend.

From a fundamental perspective, the driving force behind the USD/JPY’s multi-year uptrend has been a clear monetary policy divergence between the United States and Japan. The Federal Reserve has been incrementally withdrawing support from the U.S. dollar since it started to taper its open ended quantitative easing (QE3) program back in January 2014. After giving the U.S. economy nearly a year to stand on its own two feet, the central bank now appears likely to start raising interest rates late this year or early next year. 

By contrast, the Bank of Japan introduced its own massive QE program back in April 2013, with the explicit goal of targeting a 2% inflation rate. While this program has succeeded in driving the yen lower and Japanese equities higher, the BOJ’s stated goal of a 
2% inflation rate remains elusive, leading some analysts to speculate that the central bank could expand its QE program for a second time later this year. With the Fed looking to normalize interest rates and the BOJ potentially reaching deeper into its non-traditional monetary policy toolbox, there is clear fundamental support for continued strength in USD/JPY.

At this point, the biggest risk to the USD/JPY’s uptrend may be a change in heart by Japanese policymakers. When rates hit a new 13-year high above 125.00 back in early June, both the BOJ and Japanese government raised red flags. In nearly identical wording, BOJ Governor Kuroda noted that it was “desirable” for the forex market to move in a “stable manner” that reflected economic fundamentals, while Japanese Finance Minister Aso warned that it was important for currencies to move in a “slow and stable manner.” This coordinated jawboning of the currency suggests that policymakers may be growing uncomfortable with the yen’s continued depreciation. 

Of course, experienced traders will appreciate the irony: From 2007 to 2011, the yen relentlessly strengthened despite repeated attempts by the Japanese government and BOJ to talk the currency back down. Much like with that lucrative trend, it will take dramatic action, not just mere words, to turn around the long-term uptrend in USD/JPY (see “Yen’s course is set”). To return to our ship analogy, USD/JPY is like a big ocean freighter that has left the harbor with a head of steam, and it looks likely to keep heading northward for the foreseeable future.

About the Author

Senior Technical Analyst for FaradayResearch. Matt has actively traded various financial instruments including stocks, options, and forex since 2005. Each day, he creates research reports focusing on technical analysis of the forex, equity, and commodity markets. In his research, he utilizes candlestick patterns, classic technical indicators, and Fibonacci analysis to predict market moves. Weller is a Chartered Market Technician (CMT) and a member of the Market Technicians Association.