May 15, 2014 in Forex Articles
When we look at the trading activity in forex markets over the last several decades, one of the most consistent scenarios has been seen in Japan. For many investors, this might sound like a good thing but the opposite scenario is a much better description of the situation. Specifically, the country has been caught in several “lost decades,” where GDP annualized growth rates have been at or near zero with little reason to believe that things will be changing time soon. With growth rates lackluster at best, the Bank of Japan (BoJ) has had no reason to raise interest rates and this removes key incentives for investors to hold long term positions in the currency.
With interest rates in the Yen very close to zero for long periods of time, forex traders tend to use the Yen as a means for funding carry trades in higher yielding currencies. So, the Yen tends to have two central pegs against it: The BoJ has no reason to add incentives to buy the currency and investors have active reason to sell the currency in favor of higher yielding alternatives. This makes longer term investments an almost no-win scenario, and this is the reason why many people in Japan itself (the so-called, Ms. Watanabe) will exchange their domestic currency for foreign alternatives (such as the Australian Dollar).
Could the Tide Be Turning?
Of course, economic trends can never last forever and there is reason to believe that some short term data will start to look more positive over the next few quarters. If we think back to 2011, there was a good deal of volatility in Japanese growth data, as the Tsunami destruction and the following recovery created some erratic GDP reports. These figures have yet to completely work themselves out and quarterly growth for the first quarter of this year actually came in at 5.9%. This is obviously well above the growth rates seen in recent history and when we look at the changes seen in consumer inflation levels, so additional factors rise in importance.
Specifically, consumer prices in food and energy suggest that the BoJ will not be able to continue adding monetary stimulus at their current rates, as this is putting too much pressure on regular households. This is a positive scenario for the Yen and a negative for all pairs that are denominated in the currency. Common examples here include the USD/JPY, EUR/JPY, and GBP/JPY so those that currently have long positions in any of these forex pairs might want to consider trimming back positions on any rallies. The longer term scenarios (when looking at things from the year and decade perspectives) are still intact. But there are now reasons for why shorter term rallies in these pairs might have trouble gaining bullish traction.