The Japanese yen currently trades close to a three month low against the U.S. dollar at 153.18 late on Wednesday.
In the past, the Japanese currency has taken its cue from the difference between the interest rates of the U.S. and Japan. According to the rule, when interest rates are lower, they tend to pull currencies down. Conversely, when rates are high, they strengthen them. A negative interest rate in Japan for nearly a decade had helped the dollar to keep its advantage against the yen.
It has also narrowed the interest rate differential the very reason yen has been falling after the rate cut by the Federal Reserve and rate rise by the Bank of Japan. Thus, at this point, one may wonder why the yen continues to weaken.
Alvin Tan, Head of Asia FX strategy at RBC Capital Markets, said that the yen is still the “lowest yielding G10 currency by a significant margin.” The term G10 denotes the ten most traded currencies in the world.
Due to this fact, a long position in yen is expensive to hold, with its interest rate being considerably lower than that of its peers in currency pairing, such as the euro or the U.S. dollar.
“The one-month deposit rate in yen is +0.03% annualized, while the deposit rate in U.S. dollars is 4.76%. That’s why the yen doesn’t appreciate consistently when the Federal Reserve or European Central Bank cuts rates. The interest rate differential with the yen remains too large for most investors to justify holding it for the longer period of time.
Homin Lee, the senior macro strategist at Swiss private bank Lombard Odier, told CNBC that recent volatility in the yen likely reflected the market’s adjustment for the “re evaluation of Trump’s potential return to the Oval Office, strong U.S. growth indicators, and Japanese election risk.”.
He added that the elections in both the U.S. and Japan could make ongoing volatility in the currency pair “unavoidable in the short term.”
But any further yen weakness is likely to attract Japanese intervention, Lee said, as voters were still unhappy with the “extreme cheapness of the currency.”
Tan at RBC thinks that for the yen to rally, there needs to be a sharp deterioration in global risk appetite, saying, “the yen tends to benefit when global market volatility rises, as it is considered the premier safe haven currency.”
That would be the yen typically weakens during a risk off situation against the U.S. dollar, said Hugh Chung, chief investment advisory officer at wealth and fund platform Endowus in an interview with CNBC after this frenetic year for the yen: “When U.S. yields rise and when equities go down.
Indeed, while stock markets have been showing major declines these past few days, yields of the U.S. have been increasing and this seemed to cause the yen to depreciate by more than 1% on Wednesday.
The yen was last trading at 152.82 against the dollar.
