The value of the US Dollar rose sharply against the Japanese Yen in 2021. The broad and sustained rally saw the Japanese Yen lose approximately 12% versus the greenback last year. The sell off was significant enough to not only reverse the gains made in 2020, but to push USDJPY to five-year highs. Understanding the cause of the rally is not only important to uncovering the dynamics of USDJPY and its potential future path, it also holds significant insights into wider market sentiment and may hold clues for other currency pairs.
The most obvious and cited argument for the change in value of USDJPY is interest rate differentials. The nominal and, even more so, real rate of interest in Japan is severely negative and amongst the lowest in the world. In contrast, the United States has been treating the task of monetary tightening seriously since at least June last year, unsurprisingly coinciding with USDJPY getting its second wind in the latter half of 2021. Even looking forward, the inflation and interest rate projections suggest that this gap will widen, not shrink, adding to the argument for USDJPY to rally further. The value change can therefore be attributed in no small part to the cost of holding Japanese Yen in comparison with holding US Dollars.
The second reason, which is perhaps more subtle and less quantifiable, is risk. In particular, the market’s digestion of the risk coronavirus presents to the global economy is perhaps best expressed in USDJPY. After all, this pair was the first to react to the pandemic with a 10% jump in the value of the Yen over the US Dollar within 11 trading days as the pandemic began to unfold in February/March 2020. The sustained rally in USDJPY in 2021 alongside medical (including vaccination) advances has mirrored the markets progressive comfort with the pandemic and its diminishing threat to national economies.
2021 has begun constructively with traders seeking to acquire exposure to additional risk over safehaven assets. The discussion surrounding omicron has also moderated and even turned positive as the data on this variant has developed. USDJPY is therefore telling us that markets are less concerned about covid and beginning to price assets according to a post-covid world. Given that many assets and currencies still hold valuations consistent with the financial and economic stress the pandemic has provided, further value adjustments could follow USDJPY.
Discussion and Analysis by Charles Porter