What's next on the USD/JPY?

I think it is a good time to remember the strong correlation between the 10-year government bond spread between the U.S. and Japan and the USD/JPY exchange rate.

First, let's look at the USD/JPY exchange rate. In recent years, there have been two significant catalysts driving the depreciation of the Yen against the USD. These two main catalysts are highlighted below.

Now, the situation has changed, and these two primary factors contributing to the Yen's depreciation appear to be gaining momentum in the opposite direction. We know that many factors influence these movements and that they are not the only ones affecting the Yen's depreciation. However, it is clear that these two factors have played a major role.

The Bank of Japan (BoJ) has recently shifted to a more hawkish stance, beginning to taper its net JGB purchases. Estimates suggest this trend is expected to continue in the coming years, alongside a much tighter monetary policy. On the other hand, in the U.S., economic growth has slowed, and the FED has adopted a position entirely contrary to that of the BoJ, with a dovish stance and signaling lower interest rates for upcoming meetings.

If the expectations for both central banks are maintained and met, we can anticipate a slow but steady appreciation of the JPY against the USD given the positive correlation between spreads and exchange rate. Now, what happens if worse-than-expected data starts to be reported in the U.S.? Sharper movements, like those we have seen recently as expectations of interest rate cuts increase, could create upward pressure on the Yen as expectations of the spread differential decline.

This appears to be a structural change driven by divergent monetary policies. While many other factors influence the exchange rate between these two currencies, these two variables seem to be following a clear path.

Now, does an appreciation of the Yen against the Dollar necessarily have a negative impact on the S&P 500? Not necessarily, but we can observe a generally positive correlation between the USD/JPY exchange rate and the S&P 500.

That means that usually a strong yen leads to lower market prices, or lower market prices lead to a stronger yen. The yen is often seen as an antifragile asset, a this type of asset tends to perform well in down markets. 

More Volatility Ahead?

 Probably, the kind of move we saw in early August can't be attributed solely to the low liquidity of summer, the carry trade unwind is real. As short-term speculative positions hit the market, they may have led to a spike in volatility as leveraged positions were cut aggressively. But big institutional investors and long-term money managers will take more time to reduce their position, so more volatility is expected.

The characteristic of the JPY as a safe haven leads investors to seek refuge in it during periods of high volatility, further contributing to the currency’s appreciation.

Every time the VIX exceeds a certain threshold, the JPY tends to appreciate against the USD in the following months. We can also observe the negative correlation between these two

So, based on the factors we’ve discussed, the path of the USD/JPY appears to be towards the appreciation of the JPY. As the Yen strengthens, we can expect continued pressure on the market and increased volatility ahead.