The Dollar/Yen finished lower last week despite increased demand for risky assets. This was an unusual move because most of the time, as we’ve all seen at some point, the Japanese Yen weakens when stocks rise because of its role as a funding currency, and it tends to strengthen when demand for risk drops because it of its safe-haven characteristics.
Last week, the USD/JPY settled at 108.411, down 0.057 or -0.05%.
What the move told me is that the “normal” relationship between the Japanese Yen and bullish investor sentiment has been thrown out the window. With all of the major central banks lowering their benchmark interest rates to zero and a couple showing negative rates, stock market investors may not feel the need to use the Japanese Yen as a funding currency.
With the normal funding demand cast aside, at least for the time being, the focus for Dollar/Yen traders has shifted to the U.S. Dollar. The actions by the Fed over the past six weeks are responsible for the shift.
Last month, the Fed made available U.S. Dollars in order to stabilize the financial markets with the most liquid asset in the world – the U.S. Dollar. This triggered a huge rally in the USD/JPY. From March 9 to March 24, the Forex pair rose from 101.185 to 111.715.
Since the top on March 24 at 111.715, the USD/JPY has weakened to 106.921. This is because central banks stopped demanding dollars as they gained control of their own economies with monetary and fiscal stimulus of their own.
Now that there is enough liquidity in the market, and global equity markets have stabilized, the excess U.S. Dollars have to come out, so to speak. So investors are selling dollars.
US versus Japan Stimulus
Last Thursday, the Fed vastly expanded its efforts to save the economy with $2.3 trillion in programs aimed at helping businesses and state and local governments. The announcement sparked a jump in stocks, drop in the dollar, sell-off in bonds and rally in gold. The Fed announcement included some surprises, including its purchase of junk bond ETFs.
Two days before the Fed’s move, Japanese Prime Minister Shinzo Abe declared a state of emergency to fight coronavirus infections in major population centers and rolled out a nearly $1 trillion stimulus package to soften the economic blow.
The government approved the stimulus package, worth 108 trillion yen ($990 billion). That is equal to 20% of Japan’s economic output, more than the 11% of US output for President Trump’s stimulus package and the 5% of output for Germany’s package.
Nonetheless, the Fed pledged $2.3 trillion and Japan pledged 108 trillion yen ($990 billion). So once again, we have more dollars coming into the market, and that is bearish for the U.S. Dollar.
We saw what happened to the USD/JPY when stocks rose last week – traders sold their safe-haven dollars and moved their funds into risky assets. What we don’t know is what will happen to the USD/JPY when stocks resume their sell-off? Will investors buy the Japanese Yen or the Dollar for safe-haven protection, or will they buy both? Those are the questions investors will be facing this week.
Once again, it’s a tough call because on March 24 when U.S. stocks bottomed, the USD/JPY topped, when we were trained as traders to expect the opposite.
The best thing to do this week is to keep our powder dry until we see what the equity markets will do. They are likely to be our first indicator.
The second indicator is the stimulus package comparison. There is no question that the U.S. Fed and government have been more active during the coronavirus crisis, but that is understandable because the Bank of Japan is already working with negative rates.
Using the data we have available, I have to conclude that a stock market rally is likely to lead to a sideways USD/JPY trade, but a stock market break is likely to drive the Dollar/Yen lower.