The currency markets are trending, and one of the worst performers over the past two years has been the Japanese yen. The currency has declined by nearly 48% relative to the U.S. dollar in the past two years, and notched a seven-year low Monday.
And given the divergent paths of growth between the U.S. and Japanese economies, the Japanese yen is likely to continue to decline relative to the U.S. dollar — which means investors can continue making profits off this trend.
What’s Holding Back the Yen
One of the key drivers of currency movements is the difference between their corresponding sovereign interest rates. The interest rate differential between two-year U.S. Treasuries and two-year Japanese government bonds has moved to five-year high of 80 basis points. This interest rate differential provides investors who are willing to buy dollars and short yen a benefit of 80 basis points while holding this position over a two-year period. It also means investors who want to short the U.S. dollar will need to pay 80 basis points for this privilege. This incentive makes the dollar attractive relative to the yen.
The main catalysts for the weakness of the yen relative to the greenback is the divergent paths of the U.S. and Japanese central bank policies, as well as the trajectory of each country’s economic growth. While the Federal Reserve reduced stimulus by terminating its bond purchase program in October, the Bank of Japan surprised market participants by increasing its asset purchase program to 70 trillion yen.
Japanese Prime Minister Shinzo Abe has called for snap elections, which seem to revolve around a mandate for a continuation of his policies for economic growth. Expectations that Abe will win this week’s election and broaden the current stimulus package have created headwinds for the yen, too. Abe has postponed a planned increase to last April’s consumption tax, which in hindsight was a drag on Japanese economic growth.
Additionally, the trajectory of economic growth in the U.S. and Japan are different. On Friday, the U.S. The Labor Department released its monthly nonfarm payroll report, which was much stronger than expected.
November nonfarm payrolls grew by 321,000 jobs compared to consensus estimates by economists of an increase of 220,000 jobs. The unemployment rate was unchanged at 5.8%. Private employment rose by 314,000 compared to expectations of an increase of 220,000 jobs. Average hourly earnings increased by 0.4% compared to expectations of an increase of 0.2%.
In contrast, Japan’s third-quarter GDP declined by 1.9%, compared to expectations for a decline of 1.6%. Quarter-over-quarter, Japanese GDP fell 0.5% compared with an initial estimate of a decline of 0.4%. The main catalyst for the decline was a drop in capital expenditures.
The USD/JPY currency pair, which increases in value as the yen declines, is closing in on the 2007 highs near 124. The monthly chart of the currency pair shows that the next level of target resistance would be the 2002 highs near 135.
If you want to play for this upside, your best bet is via exchange-traded funds. Namely, you have three strong offers.
- The ProShares UltraShort Yen (YCS) looks to provide daily investment returns that correspond to twice the inverse of the daily performance of the U.S. Dollar price of the Japanese yen. In short, if the yen falls 1%, this ETF is designed to return 2% — of course, because this occurs on a daily basis, the actual returns over time can wiggle significantly, meaning the longer you hold, the less likely you are to see an actual 1-to-negative-2 correlation — you could gain more or less (or even lose out) depending on how the yen declines, not to mention you can lose big if the yen improves. This ETF costs 0.95% in expenses, or $95 for every $10,000 invested.
- The CurrencyShares Japanese Yen ETF (FXY) seeks to track the returns of the Japanese yen. Here you would need to short the ETF to benefit from a declining yen. This product is a straight-shooter with no leverage, so it’s not nearly as volatile. It also costs less at 0.4%.
- ProShares Ultra Yen (ETF) (YCL) seeks a return that is 2x the return of the daily movements of the yen, and because it’s a “bullish” play, you would need to short this ETF to benefit from a declining yen. Similar to the YCS, this ETF is leveraged and geared to aggressive traders, and also costs 0.95%.
As of this writing, David Becker did not hold a position in any of the aforementioned securities.