USD/JPY

The Japanese yen (JPY) is the third leg of the major currency/ trade bloc triangle and USD/JPY is the second most actively traded currency pair. In its role as the primary regional currency (it is also the second-largest national economy after the U.S.), the yen is frequently used as a proxy for other Asian currencies that are not freely traded or are too illiquid to trade efficiently.

For example, speculation over the revaluation of the Chinese renminbi (RMB), or yuan, as well as the actual event, has manifested itself in periods of frenzied yen-buying because the yuan is not freely traded in the spot market.

There is also a belief that a revaluation of the yuan will result in other Asian currencies strengthening in tandem. Historically, USD/JPY has been one of the most politically sensitive currencies because of the perpetual trade surplus Japan runs against the U.S. and other major economies. This made the yen a strategic bargaining lever as U.S. officials sought to open Japanese markets to foreign products, and also made it vulnerable to official U.S. or G7 pronouncements. More recently, though, China has displaced Japan as the most worrisome trading partner for the U.S., while Japan continues to emerge from a decade-long recession.

The Ministry of Finance (MOF) is the most powerful governmental department in Japan — it exercises more influence over the economic scene than the Bank of Japan (BOJ), the central bank. As recently as early 2004, the MOF via the BOJ had been waging an aggressive campaign of currency market intervention to halt a rise in the yen they believed was fueled by excessive speculation and threatened an economic recovery. In the process, the MOF/BOJ spent tens of billions of dollars propping up the greenback and limiting yen gains. The yen occupies a central place in the Japanese financial market psyche, and daily comments from MOF officials are a mainstay of USD/JPY trading.

The trading characteristics of USD/JPY are perhaps best understood by noting two key facts: Japan has the highest domestic savings and investment rate in the world, resulting in massive financial portfolios invested in financial instruments throughout the world; and Japanese cultural tendencies favor intra-Japanese cooperation and communication.

The practical effect of these two features is large concentrations of market interest at common levels, typically resulting in clusters of stop-loss and limit orders at key technical points. This herd-like behavior often results in large, volatile moves followed by extended periods of range-bound consolidation, as the pack responds en masse to breaks of key levels and then settles down. The pervasiveness of Japanese institutional interest in USD/JPY means the pair tends to respect technical levels far more than other currency pairs, with a lower likelihood of false breaks. This suggests traders need to respond more quickly to the breakout of key levels rather than waiting for pullbacks or a bounces to enter. There tends to be a “clustering” of market orders around technical levels, which favors placing stop-loss orders just beyond key technical levels (e.g., 5 to 15 pips).

The rationale here is significant limit orders will typically be in front of such levels, and the unfolding of a larger market move will be needed to get through those limit orders first. Traders focusing on USD/JPY should pay special attention to candlestick and “Ichimoku” technical analysis (a form of candlestick charting where trend, support, and resistance levels are plotted on a chart, allowing the “equilibrium” price to be seen at a glance), as they are widely followed in Asia and will frequently signal reversals or major breakouts.

Also, traders need to be aware of the major yen currency pairs, as technical breaks in these can frequently spill into USD/JPY and push it out of the driver’s seat.

Finally, liquidity in USD/JPY tends to be thinnest on the last trading day of each month and at the end of financial semesters (March and September) as Japanese institutions scale back their presence in the market at these times. The result can be highly erratic and unpredictable market movements.