Key points:
- The USDJPY pair is hovering near two-decade highs after Powell’s speech.
- The divergence between the Fed and the Bank of Japan fuels the move.
- As a result, traders expect the pair to hit new 24-year highs soon.
The USDJPY currency pair is hovering near the recent record highs printed on July 14, 2022, after Powell’s Jackson Hole speech on Friday boosted the US dollar. The relationship between the US dollar and the Japanese yen is a storied one going back to the late 1980s when the Japanese economy was booming.
Back then, many people feared that the Japanese economy was about to overtake the US economy, but what happened was a historic market crash, which the country’s economy has never fully recovered from.
Also read: Forex Market Lessons From 3 Day Traders.
Japan is a cautionary tale for other countries today about the impact of debt and extravagance, which massive crashes have always followed. The US has been through multiple boom and bust cycles, but unlike Japan, it has always recovered from each economic bust.
There are a few key differences between the Japanese and US economies, which we can’t get into now. However, Japan’s ageing population has always been blamed for the country’s inability to recover.
Now back to the USDJPY pair; both are safe haven currencies. Still, the divergence between the Federal Reserve’s hawkish and aggressive interest rate hikes and the Bank of Japan’s easy money policies has created a situation that encourages the carry trade.
The carry trade allows investors to borrow large amounts of yen, which has a much lower interest rate, then use the loans to buy US dollar-denominated bonds and earn the lucrative short-term interest rates on the dollar bonds.
If you’re wondering who would borrow a loan to trade the markets, something no retail trader should ever do, the big banks are the ones who take this kind of risk. For example, a bank can easily take a $1 billion loan (140 billion yen) to buy Treasury bills, earning a 2.87% yield on the 3-month bills while the six-month bills yield 3.33%.
The bank would earn $28.7 million at the current 2.87% yield for holding a 3-month T-bill, which is why it makes sense for them to borrow the yen at a -0.1% or 0.0% yield and buy the T-bills pocketing the yield and then repaying the yen loan.
Ordinary investors can profit from the dollar rising against the yen due to the interest rate difference by buying the USDJPY currency pair.
*This is not investment advice.
USDJPY price today.
The USDJPY currency pair was down 45.2 pips (0.33%) for the day at writing as the Japanese yen clawed back some gains.
