Will the yen keep falling?

This week, the Japanese Yen (JPY) reached its lowest level in 20 years, with the USD/JPY currency pair rising to its highest level since 2002, above 133 at the time of writing. Gaining more than 4% since the beginning of June and 15% since the beginning of the year against the American currency, the Yen is also losing ground against the single currency. The EUR/JPY reached its highest level since 2014 above 142. The pair is up more than 3% this month and almost 10% since January 2022.

Daily USDJPY Chart - Source: Platform ActivTrader from ActivTrades

Most analysts and investors believe that the difference between the Japanese and the American monetary policies will continue to support the pair, pushing the American Dollar higher and the Japanese Yen lower. Others may think that the rate differential is already priced in…

What should Forex investors expect? Why is the Japanese currency so weak? How could you take advantage of this situation? Let’s get right into it.

Why is the JPY falling?

Monetary policies and expectations about central banks’ actions are among the most significant factors driving the price of currencies on the Forex market. The interest rate differential between two countries often leads a currency pair upwards or downwards, depending on the situation.

Right now, Japan and other major economies seem to be adopting opposing trajectories.

In order to deal with runaway inflation, the RBA, the BoE, the RBNZ, the Fed, and the BoC (among other central banks) have decided to start tightening their monetary policies with less favorable credit conditions through key interest rate hikes and removals of massive economic stimulus packages adopted during the Covid-19 pandemic.

Japan, on the other hand, is not experiencing the kind of huge inflation that can be seen in the United States or in other Western economies, with inflation around its 2% target. The Japanese central bank has decided to continue supporting the local economy with low-interest rates and monetary support.

It is, therefore, easy to understand that returns on deposits and investments will be much higher in the US now (or in other countries that are increasing their main interest rates) than in Japan where rates are still low.

So, the rate differential between the U.S./Western economies and Japan is one of the reasons why the Yen is being pushed down.

Investors are, indeed, massively selling the Japanese currency to buy other currencies, such as the American Dollar. Consequently, there is less demand for the JPY as an international currency and more relative demand for other currencies like the USD: the JPY is thus cheaper, while other currencies like the EUR, the USD, and the GBP are more expensive.

The interest rate differential isn’t the only reason why the Yen keeps falling. Another important factor in the JPY's decline is that Japan is a major importer of energy, and energy prices have recently skyrocketed, especially since the war in Ukraine.

The majority of the energy in Japan, like oil and gas, comes from imports, which means that the country pays dearly when energy prices rise. With the recent global rise in commodity prices, Japan needs more US dollars to pay for its energy imports. The country must, therefore, sell JPY to buy USD in order to buy energy, which is also weighing on the USD/JPY pair.

How to take advantage of the Yen’s fall

By expecting rate differentials to widen between Japan and other western economies, Forex traders can bet that the Yen is likely to keep falling, as most central banks around the world are tightening their monetary policies to fight rising inflation, while the Bank of Japan has clearly stated that it isn’t the right time to start its monetary normalization process, despite inflation hovering around its 2% goal.

Stock investors could also take advantage of the weakness of the Yen, which usually has a positive impact on Japanese indexes, especially the Nikkei, as Japan heavily relies on exports. With a weaker currency, companies exporting goods could gain market share, as their products are less expensive relative to goods priced in other currencies (stronger currencies).

For this reason, the Yen and the Nikkei tend to be negatively correlated, which means that they move in opposite directions. When the JPY weakens, then it is usually positive for the Nikkei. On the other hand, a firmer Yen will penalize exporting companies included in the Nikkei, which tends to add bearish pressure on the Japanese index.

Traders and investors can take advantage of the Yen falling in different ways, depending on their goals.

If you want to invest over the medium to long-term, you can invest in the Forex market with the currency carry trade technique, or buy under-valued Japanese exporting companies. You can also use ETFs to get diversified exposure to the Japanese market.

In the current situation, traders will usually borrow Yen to invest the borrowed money in assets denominated in another currency, taking advantage of the interest rate differential, as well as the continued depreciation of the Japanese currency.

If you follow a more active strategy, like scalping, day trading, or swing trading, you can exploit short-term volatility on the Forex market with highly liquid currency pairs that include the Yen. But you can also trade Japanese stocks or indices over the short term.

Financial derivative products like CFD (Contracts For Difference) allow you to take advantage of bullish and bearish market conditions, thereby allowing you to open long (buy) positions to take advantage of a rise in price, as well as short (sell) positions to take advantage of falling prices, which can be great to include all market conditions in your trading.

Still, this type of trading can be quite risky, especially if you’re a novice Forex trader, so remember to always follow your trading plan, control your emotions and stick to your money and risk management rules to protect your capital.