intro – usd jpy:
USD JPY or Dollar Yen is the third most popular currency pair by traded volume in the world. JPY is also a global reserve currency, after USD, EUR and GBP. The name “Yen” translates to “round object” or “circle” in English. This is because of the perfectly round shapes of the coins. World War II played an important role in shaping up the economic and trade relations between US and Japan and therefore USD JPY exchange rate.
To begin with, we will take a look at how USD JPY came into existence. We will then look at the most important variables and factors that influence USD JPY. Finally, we will investigate how central bank policies and actions in US and Japan influence USD JPY movement.
a detour back in time
In the 19th century, silver Spanish dollar coins were used throughout Southeast Asian trading routes, the China coast, and Japan. Consequently, to save costs of bringing the silver coins minted in Latin America to Asia, local silver coins had to be minted. First one of these was the Hong Kong silver dollar coin that was minted in Hong Kong between 1866 and 1869. However, the Chinese were slow to accept unfamiliar coinage and preferred the familiar Mexican dollars. Therefore, the Hong Kong government ceased minting these coins and sold the mint machinery to Japan.
The Japanese then decided to adopt a silver dollar coinage called Yen, meaning ‘a round object’. The yen was officially adopted by the Meiji government in an Act signed on June 27, 1871. At this point, the yen was equal to a Mexican dollar(due to same weight in silver). Mexican dollar, like all dollars, descended from the “Spanish Pieces of eight”, and up until 1873 all the dollars in the world had more or less the same value.
Nevertheless, JPY devalued against the USD and the CAD(since US and Canada adhered to a gold standard), and by 1897 the yen was worth only about USD 0.50. JPY further devalued against USD following WWII, due to high inflation in post war Japan and this trend continued until 1971. However, a devalued Yen helped Japanese exports, as they were cheaper for international consumers. When USD left the gold standard in 1971, JPY, along with USD and other major world currencies, joined the free float exchange rate mechanism.
back to today
According to Office of the US trade representative website, U.S. goods and services trade with Japan totaled an estimated USD 303.0 billion in 2019. Exports were USD 123.4 billion; imports were USD 179.6 billion. The U.S. goods and services trade deficit with Japan was USD 56.3 billion in 2019.
Furthermore, Japan is currently US’s 4th largest goods trading partner with USD 218.3 billion in total (two way) goods trade during 2019. Goods exports totaled USD 74.7 billion; goods imports totaled USD 143.6 billion. The U.S. goods trade deficit with Japan was USD 69.0 billion in 2019.
In Summary, this leads to a significant amount of USD and JPY exchanging hands between individuals, corporations and governments. Therefore, this makes USD JPY, one of the most liquid and efficient fx currency market in the world.
variables and factors that impact USD JPY market
Firstly, the trade volume between Japan and US dictates the demand for JPY or USD respectively. For instance, if americans suddenly start buying a lot of Japanese cars, this will cause a spike in demand for JPY, since the Japanese car manufacturers will have to be paid in JPY. On the other hand, if Japanese car manufacturers suddenly start investing in YouTube video ads to increase their car sales, then this will lead to a spike in demand for USD, since Google(YouTube’s parent company) would want to be paid in USD.
Secondly, domestic inflation in Japan and US also impacts the USD JPY exchange rate. Higher inflation depreciates the value of the currency. For instance a higher inflation rate in Japan, means that generally a car part ‘X’ that was JPY 1000, now costs lets say, JPY 1100. This will mean that Japanese cars could now become more expensive for American consumers, leading to a potential fall in demand for Japanese cars. As a result, Japanese car manufacturers, will keep the prices consistent in USD denomination. Hence, the markets will see a depreciation in the value of JPY vs USD. Consequently, the Japanese manufacturer will get paid more JPY per USD. However, their JPY will be worth less now due to positive inflation. This is assuming zero inflation rate change in US and all other factors being static.
Thirdly, short and medium term interest rates will impact the USD JPY market as higher rates in any currency will increase the demand for that currency. As a result, the domestic currency’s value will appreciate. For instance, if the rates in US go up, the Japanese car manufacturer who got paid in USD might park the USD cash reserve in an interest paying account or buy US Govt. bonds, instead of exchanging USD into JPY.
and the rest
Finally, other factors such as unemployment rate and PMI(Purchasing Managers Index) also impact the value of USD JPY. Unemployment rate(in addition to per Capita GDP) is a measure of how much disposable income the consumers have. This has a direct impact on what consumers can spend on foreign goods . For instance, lower unemployment and higher per Capita GDP in US will increase demand for all cars(including Japanese cars). This will lead to a higher demand for JPY.
Meanwhile, a higher PMI in US will mean an increase in economic activity in US. Thereby, leading to higher employment and a high demand for USD to pay those employees.
impact of Monetary Policies
Generally speaking, Japanese monetary policy has shown deviation from western industrialised nations. While, actions on short term rates in response to inflation and employment targets are similar, there are other differences when it comes to dealing with sluggish growth and recessions.
Despite the differences, if the BoJ(Bank of Japan) is hawkish about the inflationary outlook of the economy, and raises the interest rates, it causes appreciation in value of JPY or depreciation of USD JPY. Likewise, if the BoJ has a dovish view on the Japanese economy, and keeps the ongoing interest rate stable, or cuts the interest rate, it lowers JPY value against other currencies, hence appreciation of USD JPY rate.
It is important to spend some time learning the history and basics. This time spent will yield dividends when you are trying to predict movement of an asset. Also remember that you are more rational before you place a trade. So, it’s important to set some rules. If you like market conditions and they fit what your rules suggest, go for it. If the conditions for the rules don’t fit what you see in the markets, don’t trade for it’s own sake. You don’t have to trade every day. The point of having rules is to run them to your favour, and not let them run you.
Day trading follows the same rules we use for life. Successful trading is the art of using knowledge and skills at the right time. It is also essential to set some limits once you open a position. For example, you may impose a limit on yourself to not keep a trade open for more than 20 days. Finally get access to good tools that can help you achieve your trading goals. It’s best to try out a lot of things on paper money accounts before risking your capital.
Despite of all the rules, limits and right mindset, random events will happen. So always have a contingency plan. A perfect system or rules don’t exist. And, this is a good thing. Otherwise, someone will work it out and own half of the free world. All algorithms, tools, systems and rules are based on a snapshot of data. So always pay attention to news and data on a given day.
how to apply this to trading
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