East Meets West: USD/JPY

USD/JPY is one of the more challenging currency pairs among the majors and trading in it requires a higher degree of discipline and patience. Where other currency pairs typically display routine market fluctuations and relatively steady, active trading interest, USD,/JPY seems to have an on/oft switch. It can spend hours and even days in relatively narrow ranges and then march off on a mission to a new price level.

USD/JPY can offer some of the clearest trade setups among the major pairs. When you’re right in USD/JPY, the returns can be astonishingly quick. When you’re wrong in USD/JPY, you’ll also know it pretty quickly. The key to developing a successful trading game plan in USD/JPY is to understand what drives the pair and the how price action behaves.

Trading fundamentals of USD/JPY

The Japanese yen is the third major international currency after the U.S. dollar and the European single currency, the euro. USD/JPY accounts for 17 percent of daily global trading volume, according to the 2004 BIS survey of exchange markets. Japan stands as the second largest national economy after the United States in terms of GDP and the JPY represents the third major currency group after the USD and the EUR groupings.

Trading USD/JPY by the numbers

Standard market convention is to quote USD/JPY in terms of the number of JPY per USD. For example, a USD/JPY rate of 115.35 means that it takes ¥115.35 to buy $1.

USD/JPY trades in the same direction as the overall value of the USD, and inversely to the value of the JPY. If the USD is strengthening and the JPY is weakening, the USD,/JPY rate will move higher. If the USD is weakening and the JPY is strengthening, the USD/JPY rate will move lower.

USD/JPY has the U.S. dollar as the base currency and the JPY as the secondary or counter currency. This means,

• USD/JPY is traded in amounts denominated in USD. In online currency trading platforms, standard lot sizes are $100,000, and mini lot sizes are $10,000.
• The pip value, or minimum price fluctuation, is denominated in JPY.
• Profit and loss accrue in JPY. For one standard lot position size, each pip is worth ¥1000; for one mini lot position size, each pip is worth ¥100. To convert those amounts to USD, divide the JPY amount by the USD/JPY rate. Using 115.00 as the rate, ¥l,000 = $8.70 and ¥l00 = $0.87
• Margin calculations are typically calculated in USD. So it’s a straight forward calculation using the leverage rate to see how much margin is required to hold a position in USD/JPY. At 100:1 leverage, $1,000 of available margin is needed to open a standard-size position of 100,000 USD/JPY.

It's politically sensitive to trade

USD/JPY is the most politically sensitive currency pair among the majors. Japan remains a heavily export-oriented economy, accounting for more than 40 percent of overall economic activity. This means the JPY is a critical policy lever for Japanese officials to stimulate and manage the Japanese economy and they aren’t afraid to get involved in the market to keep the JPY from strengthening beyond desired levels.

A weak currency makes a nation‘s exports cheaper to foreigners and, all other things being equal, creates a competitive advantage to gain market share. The flip side of a weak currency is that it makes imports from abroad more expensive, putting foreign exporters at a disadvantage in the domestic market.

In the past, this has led to accusations of currency manipulation by trade partners and efforts to force the JPY to strengthen. But with China's incredible growth in this decade, lil’ ol’ Japan and the yen seem to have dropped from the radar screen as the primary target of free-market advocates. But this is more a function of China's vast current and future potential rather than any change to how the Japanese effectively manage the JPY.

The Ministry of Finance is routinely involved in the Forex market

Currency intervention is usually a last resort for most major national governments. Instead, the Japanese Ministry of Finance (MOF) engages in routine verbal intervention in not-so-subtle attempts to influence the level of the JPY.The chief spokesman on currencies is, of course, the Minister of Finance, but the Vice Finance Minister for International Affairs is the more frequent commentator on forex market developments.

The Japanese financial press devotes a tremendous amount of attention to the value of the JPY, similar to how the U.S. financial media cover the Dow or S&P 500. Press briefings by MOF officials are routine. During times of forex  market volatility, expect near-daily official comments. These statements move USD/JPY on a regular basis.

Beyond such jawboning, known as verbal intervention, the MOF has been known to utilize covert intervention through the use of sizeable market orders by the pension fund of the Japanese Postal Savings Bank, known as Kampo. This is sometimes referred to as semi official intervention in various market commentaries.

JPY as a proxy for other Asian currencies

The JPY is sometimes considered as a proxy for other Asian currencies that are not freely convertible or have poor liquidity or other trading restrictions, such as the Korean won, Chinese yuan, or the Taiwan dollar. Speculation that the Chinese government would revalue (strengthen) the Chinese yuan relative to the USD in early 2005 led to speculation that the JPY would also strengthen.

Japanese asset managers tend to move together

If Americans are the ultimate consumers, then the Japanese are the consummate savers. The Japanese savings rate (the percentage of disposable income that’s not spent) is around 15 percent. (Compare that with the U.S. savings rate at around -1 percent!) As a result, Japanese financial institutions control trillions of dollars in assets, many of which find their way to investments outside of Japan. The bulk of assets are invested in fixed income securities and this means Japanese asset managers are on a continual hunt for the best yielding returns.

This theme has taken on added prominence in recent years due to extremely low domestic yields in Japan. The continual off-shoring of JPY-denominated assets leads to continual selling of JPY to buy the currencies of the ultimate investment destination. This makes domestic interest-rate yields in Japan a key long-term determinant of the JPY’s value.

Japanese financial institutions also tend to pursue a highly collegial approach to investment strategies. The result for forex markets is that Japanese asset managers tend to pursue similar investment strategies at the same time, resulting in tremendous asset flows hitting the market over a relatively short period of time. This situation has important implications for USD/JPY price action.

Important Japanese data reports

Keep in mind that politics and government officials’ (MOF) comments are quite frequent and can shift market sentiment and direction as much as, or more than, the fundamental data. The key data reports to focus on coming out of Japan are:

• Bank of Japan (BOJ) policy decisions, monthly economic assessments, and Monetary Policy Committee (MPC) member speeches
• Tankan Report (a quarterly sentiment survey of Japanese firms by the BOJ - the key is often planned capital expenditures)
• Industrial production
• Machine orders
• Trade balance and current account
• Retail trade
• Bank lending
• Domestic Corporate Goods Price index (CGPI)
• National CPI and Tokyo-area CPI
• All-Industry Activity Index and Tertiary Industry (service sector) Activity Index