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Haven yen: Why global recession could be JPY’s wild card

By Piero Cingari

13:52, 13 May 2022

The Japanese yen as a ’wild card’
At times of recession, the yen can be the joker in the forex pack – Photo: Shutterstock

The Japanese yen (USD/JPY) has been the worst performing major currency in the first five months of 2022, diving to a 20-year low versus the dollar, slapped by Federal Reserve interest rate hikes that widened the gap with the Bank of Japan’s ultra-loose monetary policy.

But despite the extreme market pessimism surrounding the yen today, the Japanese currency might yet pull a wild card out of the deck if the world economy faces a recession. Historically, the yen has been a recession-proof currency that has functioned as a tactical hedge against periods of economic stagnation.

What are the factors that might resurrect the yen, in a market that has possibly prematurely sanctioned its demise?

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US dollar-to-yen exchange rate (USD/JPY) skyrocketed in 2022

Japanese yen and recession: a positive track record

The Japanese yen (JPY) shows a positive track record during recessionary times.

Over the last six recessions in the United States, the yen has gained an average of 3.5% against the dollar, and just under 9% against the British pound (GBP/JPY). During the 2008 recession resulting from the subprime mortgage crisis in the United States, the yen gained about 14% against the dollar and 30% against the British pound. 

This shows that the yen has historically served as an extraordinary recession hedge for investors.

US RecessionUSD/JPYGBP/JPY
Jan 1980-Jul 1980-4.7%-1.4%
Jul 1981-Nov 1982+4%-7.3%
Jul 1990-Mar 1991-3.2%-9.8%
Mar 2001-Nov 2001-2.2%-1.5%
Dec 2007-Jun 2009-13.7%-30.9%
Feb 2020-Apr 2020-0.9%-2.6%
Average-3.5%-8.9%
Best+4%-1.4%
Worst-13.7%-30.9%
# of positive performance10

Credit: Capital.com, Data: Tradingview

Why does the yen’s value appreciate in a recession?

The principal driver by which the yen strengthens during recessions is the reduction of US interest rates, which is the exact reverse of the current situation.

Typically, during recessions, the Federal Reserve is called upon to support economic recovery by reducing interest rates, as declining consumption and growing unemployment tend to lower inflation. 

GBP/JPY

204.78 Price
-0.010% 1D Chg, %
Long position overnight fee 0.0106%
Short position overnight fee -0.0188%
Overnight fee time 21:00 (UTC)
Spread 0.038

EUR/USD

1.09 Price
-0.100% 1D Chg, %
Long position overnight fee -0.0088%
Short position overnight fee 0.0006%
Overnight fee time 21:00 (UTC)
Spread 0.00006

AUD/USD

0.68 Price
-0.400% 1D Chg, %
Long position overnight fee -0.0065%
Short position overnight fee -0.0017%
Overnight fee time 21:00 (UTC)
Spread 0.00006

GBP/USD

1.30 Price
-0.150% 1D Chg, %
Long position overnight fee -0.0046%
Short position overnight fee -0.0036%
Overnight fee time 21:00 (UTC)
Spread 0.00013

This causes US Treasury yields to fall, lowering the rate gap with Japanese government bonds, and therefore easing the pressure on the USD/JPY pair.

It should also be remembered that Japanese investors are the largest holders of US securities, such as equities and bonds (Treasuries). When there is a recession, Japanese investors tend to bring their foreign assets back home – raising demand for their local currency and boosting the yen.

Japanese investors are the largest foreign owners of US Treasuries  

Country

Holdings of US Treasuries
(USD bn) as of February 2022

1) JAPAN1306.3
2) CHINA1054
3) UK625.2
4) IRELAND314.8
5) LUXEMBOURG314
6) SWITZERLAND281.7
7) CAYMAN ISLANDS277.4

Credit: Capital.com; Data: Department of the Treasury/Federal Reserve Board

The yen is poised for vengeance, but when will it happen?

The rising probability of a recession provides potential for the USD/JPY exchange rate to fall from the current overbought levels. But there is no guarantee this will occur in the near future.

In the short term, the yen may continue to suffer from rising Treasury yields, which are backed by expectations of an increasingly hawkish Fed, as well as rising oil prices, as Japan is a net importer of energy commodities. Moreover, the fact that the Bank of Japan continues to stuck with its yield curve control policies – keeping Japanese bonds yields artificially low – does not support the JPY.

Whenever US inflation has topped 5% while unemployment fell below 4%, a US recession has always happened within eight quarters, and a yield curve inversion has forecast every recession since 1968, albeit with a one-year lag.

Both conditions have been met in the first quarter of 2022, but JPY’s contrarian bulls may have to wait a little longer before declaring vengeance theirs.

USD/JPY trades at extreme overbought levels

USD/JPY overboughtUSD/JPY: 14-month RSI at extreme overbought historical levels – Photo: Capital.com / Source: Tradingview

Markets in this article

GBP/JPY
GBP/JPY
204.781 USD
-0.012 -0.010%
USD/JPY
USD/JPY
157.932 USD
0.028 +0.020%

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The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
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