Author: Brian Twomey
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Many find it a complicated proposition in trading the Japanese yen against the U.S. dollar (USD/JPY). However, when the Japanese yen (JPY) is understood in terms of U.S. Treasury bonds, notes, and bills, it may become less complex.
The main driver of this currency pair is not only Treasuries but interest rates in both Japan and the U.S. This means the pair is a measure of risk that determines when to buy or sell the USD/JPY in terms of interest rates. The direction of this pair can be determined by the direction of interest rates.
Key Takeaways
- USD/JPY represents the currency exchange rate for the U.S. dollar and the Japanese yen.
- The USD/JPY currency pair has traditionally had a close correlation with U.S. Treasuries.
- When interest rates head higher, Treasury bond prices go down, which lifts the U.S. dollar, strengthening USD/JPY prices.
- The USD/JPY pair can also be a determinant of market risk.
What Is the USD/JPY Currency Pair?
The abbreviation USD/JPY represents the currency exchange rate for the U.S. dollar and the Japanese yen. The pair shows how many yen are required to buy one U.S. dollar—the quote currency and base currency respectively. The pair’s exchange rate is one of the most liquid, not to mention one of the most traded, pairs in the world. That’s because the yen, just like the U.S. dollar, is used as a reserve currency.
Currency traders generally know the best time to trade this currency pair is between 8 a.m. and 11 a.m. ET. There is a bigger chance of finding the biggest price moves, as there is more movement and more volatility in the market during this three-hour period. Even though the markets in Tokyo aren’t open, they are both open in London and New York.
USD/JPY Relationship With Treasuries
The USD/JPY currency pair has traditionally had a close correlation with U.S. Treasuries. When yields on Treasury bonds, notes, and bills rise, the Yen tends to weaken relative to the dollar. This is because people can borrow Yen more cheaply to buy higher-yielding dollars. Generally, higher interest rates increase the value of a country’s currency.
Thus increasing interest rates in the U.S. (accompanied by lower Treasuries prices), often causes the USD to strengthen relative to the JPY. strengthen, Yields, defined as the rate of interest paid on a Treasury instrument, have an inverse relationship with bond prices. Therefore, when yields slump, a flight to liquidity occurs and this liquidity must find a home, which is where currencies can become attractive.
Market Trends Related to the Currency Pair
The USD/JPY pair can also be a determinant of market risk. For example, when markets are in search of risk trades, Treasury bond yields rise as the economy grows. Yields are also a signal of risk. In the case that panic or fear hits the markets, Treasury bond prices tend to rise, causing yields to fall. In such a case the price of the U.S. dollar can weaken against the Yen.
However, Japan has maintained very low interest rates for quite some time. This has led to the yen’s status as the premier funding currency. For example, by selling a lower-yielding currency such as the yen with current interest rates below its major trading partners—the U.K., U.S., Canada, Switzerland, Australia, and New Zealand—investors can seek higher interest rate instruments within its major trading partners for carry trade purposes.
Carry trades have been a major funding source for investors. For instance, if you sell the USD/JPY for U.S. dollars and use those dollars to obtain higher-yielding instruments such as Treasury bonds, then you’re able to boost your returns.
Important
You can boost your returns if you sell the USD/JPY for U.S. dollars and use those dollars to obtain-higher yielding instruments such as Treasury bonds.
Monitoring USD/JPY Opportunities
Short- and long-term investors may want to employ different strategies when it comes to trading the USD/JPY pair. For instance, short-term traders may want to monitor two-year Treasury bonds and the stock market, while long-term traders would benefit from paying attention to the 10- and 30-year bond numbers.
Due to the nature of the USD/JPY pair’s correlations to the stock and bond markets, it is worth looking at the S&P 500 indexes for possible early warnings of changes in correlations.
These changes in correlations may occur for several reasons. For example, if the U.S. issues more debt by sales of Treasury bonds and adds money to the system, bond prices may dilute and have varying effects on the USD/JPY pair. What if the U.S. buys back Treasury bonds and adds money to the system? Would that mean a positive correlation for the USD/JPY pair? The answer is varied in that it is based on good economic outlooks versus recessionary environments.
How Does the Balance of Trade Affect USD/JPY?
Nations with trade surpluses will often see the USD/JPY pair as a favorable investment because the market traditionally views this pair as a chance to seek greater buying power and higher interest.
What Does It Mean to Be Long or Short the USD/JPY?
Currencies trade in pairs. This means that you will always go long (buy) one currency to go short (sell) the other. This will correspond with the first currency (known as the base currency). So to go long the USD/JPY would be to buy Dollars and sell Yen. Going short the pair would entail the opposite.
How Many Yen Is One Dollar Worth?
The prices of the U.S. Dollar and Japanese Yen float freely against one another on the forex market. As a result, the exchange rate between the two will change from day to day and trend over time. As of June 2, 2024, $1 USD is worth roughly 157.32 JPY, almost as high as the peak rate of 158.9 in the late 1990s.
The Bottom Line
When evaluating the relationship between the USD/JPY currency pair, the economic laws of supply and demand will ultimately serve as a strong factor in pricing but is also closely tied to bond pricing in their respective countries. One way investors express their views on the pair is through a carry trade, commonly viewed by the market as a negative for Japan’s economy because it deflates its currency—this is a USD/JPY short.
Yet if Japan repatriated its yen home, this would be USD/JPY positive and a buy indicator because it weakens its currency and strengthens its economy.
Correction—April 17, 2023: The definition of going long or short the USD/JPY pair has been amended to reflect which one you buy or sell.
Read the original article on Investopedia.