2010 was a wild year for USD JPY as bears attacked the pair mercilessly, driving it down in a very clean trend to all-time lows by year end. In late October, USD JPY hit its all-time low of 80.20. In this article, we are going to discuss what drove USD JPY down so aggressively in 2010, a few key characteristics of both the dollar and the yen, and we will conclude with a brief analysis of where it could be headed in 2011.
Risk Aversion & Risk Appetite
These are the two psychological mindsets that rule the market at any given time. During times of risk aversion, traders get scared and direct their capital out of risky investments and into safe, conservative investments. During times of risk appetite, traders shift capital out of safe, conservative investments and into riskier investments , as they are in search of higher yield potential. Thus, during times of risk appetite, global equity markets rally, commodities rally, and higher-yielding currencies rally. During times of risk aversion, all of these things fall, and low-yielding, safe currencies will rise in value.
The U.S. dollar is seen as a very safe investment since there is very little chance the U.S. government would default on its sovereign debt. Therefore, during times of risk aversion, the U.S. dollar tends to far outperform most other currencies such as the euro, British pound, Aussie dollar, etc. However, one currency that it does not outperform is the Japanese yen. During times of risk aversion, the Japanese yen tends to outperform even the U.S. dollar.
This is very important to know. It means that when there are major global risk events spreading contagion of fear throughout financial market, you can be assured that Japanese yen will most likely rise against every currency, including the U.S. dollar. The reason is simple. The Japanese government has a huge debt-to-gdp ratio, but most of its debt is held domestically by the Japanese people.
This means that Japan’s government is not dependent on foreign investors to finance its operations and issue new debt. This is seen as a major advantage and provides very little chance of Japan ever defaulting on its debt, which, in turn, makes it an extremely safe bet. Thus, capital tends to flow into the Japanese yen during times of great uncertainty. Well, things were quite uncertain in the first half of 2010 as Greece’s sovereign woes disrupted financial markets around the world.
Then, as soon as Greece was bailed out in early June 2010, the U.S. economy hit a major wall and began showing signs of serious deterioration. This led the U.S. dollar to continue falling against the Japanese yen until USD/JPY finally hit an all-time low of 83.20 on October 1, 2010.
Many analysts are now calling for a strong rally in USD JPY in 2011 because of two reasons. First of all, the U.S. economy has been posting positive economic data for the last few months, and it looks like the recovery will be strong in 2011. This means there is not as bearish of a view on the U.S economy. Second of all, the Japanese economy is not doing great. Japan’s sovereign credit rating was downgraded in early 2011, and China has been aggressively raising interest rates in early 2011, which could weigh on economic growth in Japan since China is Japan’s largest trading partner.
You can see in the chart above, that USD/JPY has just broke above key overhead resistance and is now using that level as support, which could lead to a further move to the upside.