The Japanese government reacted promptly to the COVID-19 pandemic. The pandemic stimulus measures destined to help the economy have fallen short of the headline numbers, yet the local currency remains weak.
The Japanese yen is one of the most interesting currencies to analyse, interpret, and trade. For years, it acted as a safe-haven currency, in the sense that in times of market turmoil, investors’ appetite for the yen increased.
It did so during the COVID-19 pandemic, too. Initially, the USD/JPY pair, the most relevant when it comes to interpreting the Japanese yen’s strength or weakness, fell. Only after the central banks in the developed world stepped up and eased the policies did the pair recover, together with the global stock markets.
While the monetary policy measures were more or less identical throughout the advanced economies, the fiscal measures differed dramatically. The moves in the fiscal space made the difference in trading the currency market during the pandemic, and the Japanese yen, once again, diverged from the status quo.
The greater the fiscal stimulus, the waker the currency
The rule of thumb in interpreting monetary and fiscal policies is that the more the central banks and governments do, the weaker the currency becomes. Think of the United States, which delivered a fiscal stimulus of 16.7% of GDP in response to the COVID-19 economic shock. But that was without the American Rescue Plan, which is supposed to add another 8.9%.
In Japan, the government delivered three stimulus packages worth over 300 trillion yen. This number is huge and exceeds 50% of GDP – the largest fiscal package of all the G7 countries. However, there is a catch. If we discount non-government spending with no impact on aggregate demand, the package is only worth about 16% of Japan’s GDP.
This is an interesting take because it helps traders understand the chart above. The USD/JPY initially declined during the pandemic, only to bounce over nine big figures (i.e. nine hundred pips) in 2021.
More stimulus, therefore, leads to a weaker currency, but the actual spending is far less than the headline numbers. Therefore, an unwind (i.e. reversal) of the Japanese yen’s weakness should not be discounted once markets understand the real size of the fiscal stimulus.