The Japanese Yen (JPY) is one of the weakest currencies this year so far. The flagship currency pair, the USDJPY, rose from 101 to over 110 yesterday – a strong, bullish trend, with few retracements and ongoing strength.
In fact, it is not only the USD that gained against the JPY, as the decline in the yen has been more accentuated on other currency pairs. Take, for instance, the GBPJPY cross – while the GBPUSD reached 1.42, the GBPJPY bullishness was even more accentuated due to the ongoing strength in the USDJPY.
When interpreting correlations on the FX dashboard, traders are better off considering and analyzing two majors and one cross. In this case, both the GBPUSD and the USDJPY moved higher overall, and that means that the rally on the GBPJPY was the strongest.
To many, the weakness seen in the JPY pairs is surprising. The Bank of Japan signaled its intentions of easing the pressure on the yield curve by widening the band around the zero level, yet the yen depreciated instead of doing the opposite.
A weaker currency bodes well for the local stock market, so many investment houses see the Japanese equity market as full of potential for the months ahead. When compared to the U.S. or European equities, the Japanese small value corporations are seen as having higher growth potential for the years ahead, fueled by a lower currency.
Higher U.S. Real Rates Bode Well for Value/Growth and Weaker JPY
When the Bank of Japan announced the introduction of quantitative easing for the first time, the JPY sold drastically across the board. To exemplify, think of the USDJPY exchange rate that rose from below 80 to over 120 in a dramatic move higher.
The point here is that when the Bank of Japan wants something, it gets, despite not being that successful in reaching the desired inflation target. It appears that the market does not believe in the Bank of Japan easing the pressure on the long-term yields, and so the JPY continues its downtrend.
However, the market participants like the fact that the Fed does not target lower yields and let the market forces determine the price (for now). Therefore, higher U.S. real rates bode well for the dollar but also for value/growth equities.
One of the strongest correlations in financial markets is the one between yields and the JPY and CHF. Seen as safe-haven currencies, the two get stronger when the yields drop, and they weaken when the yields rise.
To sum up, lower yields in Japan, higher U.S. rates in the United States, and a flexible Bank of Japan that continues to buy equity ETFs when needed, create the perfect scenario for a bullish trend in Japanese small value stocks. Is anyone surprised that one of the investments made by the legendary Warren Buffett in 2020 was in five Japanese companies?