Dollar Hits Seven-Year High against Yen

Posted on Nov 20, 2014 in Blog

A strengthening US economy combined with a shaky Japanese financial climate has led to the Dollar reaching its highest level against the Yen since August 2007. A series of grim economic results have played a significant part in the Yen’s drop, and the Nikkei has strengthened considerably as a result of the Yen’s decline.

The Inverse Correlation Between the Yen and the Nikkei

Over the last month the Yen has dropped substantially against USD, going from a level of 1:106.405 on October 17th to 116.896 on November 18th. At the same time, the Nikkei has shot up over the last month, from a level of 14, 804.28 on October 21st to a level of 17,344.06 on November 18th. In both cases, these levels have not been seen since July 2007, just before the housing bubble in the US burst and precipitated the most recent recession.

Why is this? The reason most commonly given is that a weaker Yen enables Japanese businesses – which are largely focussed on exports – to compete favourably abroad, strengthening earnings, which can lead to a boost in stock prices as well as to the Nikkei as a whole.

‘Abenomics’

The Prime Minister of Japan, Shinzo Abe, came into office in late 2012 on the strength of a financial plan which quickly became known as ‘Abenomics’. Abenomics incorporates a so-called ‘three arrows’ approach, the arrows in question being 1) Fiscal Stimulus 2) Monetary Easing and 3) Structural Reforms. The over-arching message was that significant and possibly painful measures were needed to combat the yawning chasm of Japan’s public debt.

The Sales Tax Increase, Recession and Another Election

Unfortunately, one of the measures introduced this year has caused a lot more discomfort than was expected. In April Mr Abe increased Japanese Sales Tax from 5% to 8%. However, this caused Japan’s GDP to drop significantly in Q2, and a further (though smaller) drop in Q3 means that the world’s third largest economy finds itself in the unenviable position of having officially entered a triple-dip recession. Given the current situation, Mr Abe has delayed plans for a further planned Sales Tax increase (this time to 10%) and on Tuesday announced that he will go to the polls in order to ensure continued support for his programme of reforms – the election is expected to take place in mid-December. If Abe is re-elected with a strong showing, it may help to give the Yen a boost, but equally it might cause the Yen to slump if Abe then pushes on with further tough economic measures. If Abe loses – or even if he wins by a narrow margin – it’s hard to see how things could improve for the Yen: is a tough financial plan that causes significant economic pain better than not having any sort of economic plan at all?

Dollar-Yen in the Months Ahead

Given that it’s difficult to see how things will get better for Japan in the near future, a wide variety of analysts are strongly recommending that traders buy Dollar-Yen, with the majority opining that the Yen’s decline still has some way to go. Of course the Yen could prove detractors wrong, though – or the US economy could halt and possibly even reverse some of its recovery, which might send the Dollar tumbling against all currencies, including the Yen. All this, however, is pure speculation. In the months ahead we’ll see whether the analysts’ predictions are borne out or if they turn out to be way off the mark.

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