As one of the four major currency pairs, USD/JPY is closely watched by IG investors. Currently, 70% of client accounts are short on the pair. With inflation in Japan stable, and monetary policy loose, these could be position trades, held for months or even years. At a multi-year low, 1 dollar will buy 114.24 yen right now. And it could fall even further.

Japanese elections

Yesterday, Fumio Kishida’s Liberal Democratic Party won an outright electoral majority. The party secured 261 seats, 28 more than the 233 needed to govern without a coalition partner. Japan’s Nikkei 225 and TOPIX indices both rose over 2% today, as investors believe that the new Prime Minister can now push through his economic stimulus plans worth trillions of yen.

Kishida is selling his economic policy as the ‘new capitalism,’ while its detractors on social media are likening it to China’s ‘common prosperity.’ One fierce critic, Rakuten’s CEO Hiroshi Mikitani, tweeted ‘Does he even understand how capitalism works?’ He was particularly unhappy with proposals to raise Capital Gains Tax (CGT) amid fears it would halt the rise of retail investors in the country. When Kishida took over as Prime Minister a few weeks ago, Japan’s stock markets fell sharply, forcing him to backtrack on his CGT policy. But with a fresh mandate, the plan could now resurface.

Kishida believes a new economic policy is needed to distribute wealth more fairly in Japan. His predecessors, Yoshihide Suga and Shinzo Abe, pursued ‘Abenomics,’ which consisted of aggressive monetary easing, fiscal consolidation and growth. Overall, Abenomics was successful at growing Japan’s previously sluggish economy. The Nikkei 225 went from 10,000 yen in 2012 to 30,000 yen by February 2021.

However, Kishida contends that Abenomics has only helped to make the rich richer. There’s some merit to this argument — according to the Organisation for Economic Co-operation and Development, average wages in Japan have stagnated compared to the US and Germany. And 10% of the 2,500 companies on the Tokyo stock exchange now have cash and deposits worth more than their market caps.

Will the Japanese yen weaken even further against the US dollar?

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Monetary policy

The Bank of Japan is sticking to an ultra-loose monetary policy. This sets it apart from almost every other central bank. In the US, it’s likely that the Federal Reserve will soon announce ‘tapering’ of its pandemic stimulus as well as interest rate rises next year. Athanasios Vamvakidis, head of G10 forex strategy at Bank of America said that ‘we have a real policy divergence here….the Fed might start hiking next year, while the Bank of Japan is stuck at zero.’

Meanwhile, the bank’s Governor Haruhiko Kuroda said that ‘The positive impact on exports and corporate profits at the overseas subsidiaries of Japanese companies far exceeds the negative impact of rising import costs…under the current economic and price conditions, the yen's weakening to this extent is no doubt a plus.’ And last week, he announced that the Bank would keep short-term interest rates at -0.1% and continue to buy exchange-traded funds with an upper purchase limit of 12 trillion yen.

And Kishida’s plans for a new 10 trillion-yen university endowment fund could send the currency sinking even lower. Forex speculators would likely sell the currency as the newly created yen hits the international money markets. Moreover, Japan depends on imported energy, which is becoming ever more expensive. The country will have to spend increasingly more yen to acquire the oil and gas it needs, which will also harm the currency.

So the yen could weaken even further in the short term. However, Japan is a low inflation country in a world where inflation is causing headaches everywhere else. Investors could come flooding back to the currency should there be another global financial crash. And it’s also possible that investors are overreacting to the new political situation.

Charles Archer | Financial Writer, London
02 November 2021