What’s up forex fiends! With the new year around the corner it’s time for our quick currency recaps in case you need to get up to speed to what has been a craaazy year. And to kick’em off, we’ll start with the Japanese yen!
First, let’s take a look at economic developments in Japan’s, and at a glance it’s been a pretty solid year of improvement for the Japanese economy in terms of headline numbers:
Growth Domestic Product (GDP):
The first three quarters showed reads above the 20 year average of 0.60% per quarter GDP annualized with 1.60% annualized growth in Q1, 2.80% annualized in Q2 and 2.40% annualized in Q3. This confirms the steady rise in business and consumer sentiment conditions that have been trending higher for the past three years, and pretty much to their strongest levels since the Great Recession of 2008.
Japan’s unemployment rate spent most of its time around 2.8%, levels not seen since the early 1990’s and the labor force participation rate jumped to hit five year highs and is now reaching pre-Great Recession levels around 61%.
Inflation, while still historically weak, is showing signs of rising prices in the consumer price index, the core consumer price index, and most notably in the producer price index (up for eleven straight months), all up in 2017. Unfortunately, the rate of price growth is still far from the Bank of Japan’s target of 2.00%, with CPI coming in at an average of around 0.40% year-over-year each month.
And in terms of trade, it’s also been a strong year after a rough January start with November marking the sixth month in a row of trade surplus, with big contributors coming from semiconductor manufacturing equipment demand from China and cars to the United States.
With all of these positive headline developments, you’re probably thinking that it’s about time for the Bank of Japan to make some policy moves right? Well, if you’re thinking that, you’d be wrong buddy…sorry!
Bank of Japan and Monetary Policy
In 2017, the Bank of Japan made no changes to their monetary policy, keeping the steady mantra of focusing on their 2% inflation target and their QQE With Yield Curve Control monetary policy framework. For those who don’t know what all that mumbo jumbo means, at a very simplistic level, it means that the BOJ will keep Japanese government bond (JGB) yields close to 0% through unlimited bond purchases (which tends to drive down the value of the yen) to help stimulate the Japanese economy.
So, even with the positive developments in the economic data above, if we don’t see that inflation chart rising at a faster pace towards their target growth rate, the Bank of Japan is not likely to move an inch towards tightening their stimulus program.
With that said, the BOJ did recognize the uptrends and presented upbeat outlooks on growth at each policy statement this year as early as January, but ideas of a stimulus exit were quickly shot down with consistent inflation outlook downgrades, like the one we saw back in July.
By the end of the year, however, yen bulls saw a glimmer of hope for hints of a future exit of loose policy by BOJ Governor Kuroda at the December meeting, but didn’t hesitate to remind us all that it’s still too early at this time.
With the BOJ not making any changes all year as expected by the market, it’s safe to say the BOJ monetary policy statements were generally duds for volatility junkies, maybe with an exception to a jab at Trump’s protectionist policy ideas or threats of intervention from the BOJ in May, which I’ll touch on in a bit.
For long-time readers of BabyPips.com, y’all know that the Japanese yen hasn’t been one to normally move on Japan’s economic data releases or the Bank of Japan’s monetary policy statements. No sir..it’s all about global risk sentiment and bond yields!
And for newbies out there who don’t yet understand how bond yields affect currency movements and why the yen tends to correlate with the U.S. Treasury 10-yr yield, it was explained in the Japanese yen review of this weekly post, so read up there to get up to speed.
For those who are up to speed on this relationship, let’s see if it held true in 2017:
Because of Japan’s low interest rates and the yen’s status as a safe-haven currency, daily price action in the Japanese yen continued to correlate strongly with global bond yields and broad risk sentiment. Crunching the daily close prices above, we saw a roughly 76% correlation between USD/JPY and the 10-yr U.S. Treasury bond yield.
As for what drove risk sentiment throughout the year, there are literally dozens of events that sparked volatility and directional movement. I couldn’t possibly go through all of them here, but if I were to pick out major themes that had global risk sentiment jumping intra-week, it would have to be:
- Shifts in sentiment on U.S. Monetary Policy – a hawkish Fed development tended (like New York Fed President William Dudley’s June speech) to spark a rise in bond yields and yen to fall, and vice versa.
- U.S. Healthcare and Tax Reform – negative developments in Trump’s reform plans tended to spark global risk-off sentiment (i.e., lower bond yields and higher yen) and vice versa.
- Geopolitical risks – When global fears rose on the probability of military action, political elections, terrorist attacks (e.g, subway explosion in Russia), etc., we tended to see bond yields fall and the Japanese yen rise as traders run to safe havens. When fears would subside, bond yields would rise and the Japanese yen fall.
Of course, there were situations where the Japanese yen would decouple from its correlation with bond yields, the most notable are the North Korean missile tests over Japan, which Japanese Finance Minister Taro Aso first warned of yen’s status as safe haven currency back in early May.
Finally, when comparing the Japanese yen to the rest of the major currencies in 2017, we saw two general moves in yen pairs:
We first saw broad yen strength in the first quarter of 2017, which I think I can be mainly attributed to political uncertainty in Europe (French and Dutch elections) & disappointment over Trump’s fiscal plans and potential conflict between the U.S. and North Korea.
But in the second quarter of 2017, we saw a turn higher in yen pairs and I think the catalyst for this reversal may have been rumors of possible intervention from Japanese officials. With the yen appreciating in Q1 to levels that Japanese officials considered hurtful to Japan’s export economy, Japanese Finance Minister Taro Aso threatened action to prevent excessive yen gains in May.
From there, yen sellers took control and never looked back for the rest of 2017 on what was likely a combination of subsiding extreme fears of military action between North Korea and the U.S., the U.S. getting closer and closer to potentially stimulative fiscal reforms, and in my opinion, most likely on the fact that economic conditions and sentiment have been improving across the globe.
Yes, the world economy is recovering, and one example can be seen back in July when the International Monetary Fund released their World Economic Outlook update, which showed a firming recovery and a projected global growth rate of 3.5% in 2017 and 3.6% in 2018, and then an upgrade to both numbers in October. This is likely to be the best growth since 2011, and within this environment, it makes sense we’re seeing a broad growth in risk appetite throughout 2017, decreasing demand for safe havens like the yen and government bonds. And as of this writing, it looks like the yen is going to lose out to most of the higher-yielding currencies in 2017.
One last thing I’d like to note is price volatility. In the chart above, I added the 20 daily ATR of USD/JPY to the bottom of the chart, and we can clearly see that volatility was in decline through the majority of the year (peaking around 150 pips/day to its current level around 70 pips/day), likely making it tough for short-term traders to grab some pips.
So, similar to 2016, the Japanese yen saw broad gains early before being taken to the wood shed for the rest of 2017 on rising economic sentiment, subsiding geopolitical fears. And going forward, if global growth continues to expand, inflation growth conditions remained subdued in Japan, and the major global powers can find a way to play nice with each other, 2018 could be another tough year for the Japanese yen and other safe havens.
Of course, that can all change in an instant on geopolitical surprises, so it may pay to stay on top of global politics and events because based on 2017, it seems like it doesn’t take much to get bond yields and the yen to move with every news headline.