HomeStronger JPY Leads Nikkei 225 Higher

Stronger JPY Leads Nikkei 225 Higher

One of the world’s stock market indices that performed best during the pandemic is the Nikkei 225 in Japan. It is up 72% since the low in March, and funds are still pouring into it. 

So far, nothing strange in this picture. After all, a close comparison with other indices around the world reveals similar patterns – a dip in March 2020 followed by a sharp rebound.

What is different here is the fact that at the same time, the local currency, the Japanese Yen (JPY), appreciated. All this time that the Nikkei made new highs, the JPY rose especially against the USD.

The trend is seen throughout Asia. In 2020, Asian emerging markets’ currencies will appreciate significantly against the USD. Will the trend continue in 2021?

What to Expect from the Japanese Economy and the JPY in 2021?

The Japanese Gross Domestic Product (GDP) contracted in 2020 by -5.5%. Support from the Bank of Japan and the government made the economy resilient in the face of the COVID-19 adversities.

Consumer behavior in 2020 was affected by two factors. On the one hand, the sales tax hike affected the retail sales numbers. On the other hand, the pandemic distorted them further. Therefore, as Japan prepares for a gradual recovery, the GDP is projected by 3% in 2021, followed by a further +2% in 2022, with private consumption to drive Japan’s recovery.

At the same time, JPY appreciation poses a problem for the Bank of Japan. Just like in the case of the Swiss National Bank, the JPY appreciates during economic recessions because investors look for its safe-haven qualities.

For the Bank of Japan, outright deflation is a problem it faces for many years. To fight it, it lowered the rates into negative territory and kept them there for a long time. Moreover, the Bank of Japan is one of the biggest investors in the local equity market – justifying the elevated levels we see on the Nikkei 225 index.

It is unlikely that the central bank will lower the rates more into negative territory in the year ahead. However, it all depends on the JPY and how much it strengthens. The threshold appears to be the 100 level on the USDJPY pair – a move below would trigger the Bank of Japan’s attention.

Last time the USDJPY traded at the 100 level was right after Donald Trump’s election more than four years ago. The pair bounced sharply from there – almost two thousand points.

Will it bounce again if JPY strengthens that much?

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