Why Traders Are Selling JPY

Many retail traders are likely starting their morning off in disappointing fashion as USDJPY continues to climb higher while they short the pair, betting on an elusive JPY comeback. Up 0.37% at the time of writing today, or over 50 pips intraday, the pair has reached 136.65 as the Yen selloff continues, reaching levels not seen since 1998. Many other JPY pairs have followed suit as the Yen displays shocking weakness, with the latest COT data revealing 72.45% of institutional traders shorting JPY. While analysts disagree about how long the selloff will last, or what the implications will be for Japan’s economy, retail traders must first acknowledge that this selloff is happening for concrete reasons. Let’s discuss why traders are selling JPY.

Bank of Japan Dovishness

The Bank of Japan (BoJ), Japan’s central bank, is continuing to take extreme measures in an urgent attempt to stimulate Japan’s economy via expansionary monetary policy. This dovish agenda, which was somewhat revamped and unveiled in 2016, includes features such as negative short-term interest rates, as well as a program called Quantitative and Qualitative Easing with Yield Curve Control. This is a robust asset purchasing program with a special focus on keeping 10-year Japanese Government Bond (JGB) yields at approximately 0%. This sheer degree of monetary stimulus helps establish the BoJ as a, if not the, pioneer of contemporary dovishness.

As of June 20^th, 2022, the BoJ’s balance sheet has swelled to over ¥742 trillion, or over $5.4 trillion, comfortably larger than Japan’s GDP itself. By contrast, the Federal Reserve’s gargantuan balance sheet, nearly $9 trillion, is less than half of US GDP. Likewise, Japan’s public debt is estimated to currently exceed 260% of GDP, which is utterly unique in the developed world. These are some of the consequences of ultraloose monetary policy and ambitious fiscal policy, and would contribute to making it difficult for Japan to raise interest rates. These are strong, clear-cut bearish fundamental indications for JPY.

No Economic Overheating

It would be reasonable to ask: wouldn’t this degree of ultraloose monetary policy lead to rampant hyperinflation, forcing future rate hikes, which would be bullish for JPY? In many cases, yes. In fact, building towards increased inflation is certainly the goal of the BoJ’s agenda. However, hyperinflation appears to only be a distant concern for Japan because they have been contending with deflation for decades. As many analysts have observed, economic factors such as comparatively slow population and nominal wage growth have concomitantly fostered conditions for sluggish demand, causing unusually low inflation.

The BoJ has thus maintained a years-long goal of hitting a consistent 2% or higher year-over-year inflation rate, which has typically proved evasive. While Japan’s annual inflation rate did finally reach, then remain at 2.5% in April and May of this year, considering how long they have sought these numbers, the BoJ will likely continue its dovishness to ensure deflation is behind them. This casts a uniquely bearish light on JPY, because unlike the COVID-era dovish Federal Reserve, the BoJ likely won’t pump the brakes on stimulus anytime soon.

A Global Change of Tune

Japan’s current economic circumstances are so uncommon relative to other developed countries that this has exacerbated the BoJ’s divergence from most other central banks in terms of monetary policy. While Japan is finally starting to see CPI grow as the fruit of monetary and fiscal stimulus, most other countries’ central banks are rolling the dice on recession by tightening monetary policy to stamp out stagflation risks.

For example, in the US, annual inflation clocks in at 8.6%, with the Federal Reserve opting for a 1.75% target interest rate; in the UK, annual inflation has reached a staggering 9.1%, with the Bank of England choosing a 1.25% target interest rate. Even Switzerland and the EU, which also boast negative target interest rates, have proved open to rate hikes. By contrast, Japan’s target interest rate remains at -0.1% while annual inflation only just surpassed 2%.

The hyperinflation problem is so prevalent in much of the developed world, yet so different than the problem(s) the BoJ must face, that most central banks will probably settle on further respective rate hikes before the BoJ has to follow suit. Thus, the increased hawkishness of most other central banks is additionally bearish for JPY, since demand for other currencies is steadily growing, but not for the Yen. While some analysts anticipate the BoJ being forced to combat the Yen’s devaluation soon, there currently seems to be little evidence that this is around the corner.

Best JPY Pairs to Trade

According to the EdgeFinder, an A1 Trading tool that generates helpful buy or sell signals by compiling elements of fundamental, technical, and sentiment analysis, here are the most promising JPY pairs to trade: 1) CADJPY, which receives a score of 5, a ‘Buy’ signal. Some factors that contribute to this bullishness include institutional positions, trend reading, and interest rate divergence. 2) EURJPY, which receives a score of 4, another ‘Buy’ signal. Factors that contribute to this bullishness are nearly identical to those for CADJPY. 3) CHFJPY, which receives a score of 4, another ‘Buy’ signal. Some factors that contribute to this bullishness include unemployment data, trend reading, and GDP growth. It is also worth noting that these three scores are currently the strongest ‘Buy’ signals that the EdgeFinder displays.

Key Takeaways

• The Bank of Japan (BoJ) has thus far opted to continue its years-long focus on dovish monetary policy, including negative interest rates and a massive asset purchasing program, which has caused the BoJ’s balance sheet and Japan's public debt to balloon.
• The primary reason why the BoJ has not shifted towards tightening monetary policy is because they have been fighting off deflation for decades by perpetually stimulating Japan's economy.
• As other countries’ central banks are becoming increasingly hawkish to address inflation concerns, the BoJ is fighting entirely different battles, trying to create more demand in Japan.
• These conditions are exceptionally bearish for JPY and seem unlikely to change soon.
• According to the EdgeFinder tool, the optimal way to sell JPY is to buy these pairs: CADJPY, EURJPY, and CHFJPY.