History Of The Japanese Yen

The Japanese yen has been the national currency of Japan dating back to its introduction in 1872. Yen banknotes were initially created in an attempt to modernise Japan's currency, and their value was linked to the market value of gold. Upon the devaluation of the currency in the immediate post World War II era, the yen was "pegged" to the United States dollar and remained so until the dissolution of the Bretton Woods monetary system in 1971.

The early 1970s marked the beginning of the current monetary system in Japan. As the United States dollar ended its relationship with gold, the yen was allowed to become a "free floating" currency. In the truest sense, a free floating currency derives its value from the world's currency markets. However, in the case of the yen, the Japanese government implemented a "dirty float" policy of currency management.

Essentially, what being under a dirty float policy entails is that the government and national banks of Japan focus on keeping the yen stable at artificially low levels. These low levels are advantageous to the huge export sector of the country's economy and are fostered by national monetary policy.^[1]

Bank Of Japan

The country's central banking authority is the Bank of Japan, which was created under the Bank of Japan Act in 1882. It remains the entity commissioned with the management of the yen.^[2]

The main objective of the Bank of Japan concerning the yen is maintaining the price stability of domestic goods and services. Unlike the central banks of most other economic powers, the Bank of Japan does not establish a "target inflation rate." Instead the BOJ employs a "price stability target," which directly addresses the issue of the pricing stability of
domestic goods and services. The BOJ takes a hard line against any undue inflation in consumer and producer pricing, and crafts monetary policy with the goal of ensuring price stability.^[3]

One of the major drivers of volatility concerning the yen is the monthly Bank of Japan Announcements. These are not given at a designated time (like other central banks). Instead, they are made as soon as the meeting bodies of the monetary policy board have concluded their business.

The lack of a specific schedule for the announcements can throw short-term exchange rate volatility facing the yen into a chaotic state. Sentiment from the Bank of Japan concerning the tightening or loosening of monetary policy can swing yen valuations dramatically in a matter of seconds. The lack of a definitive schedule regarding the new release can cause market conditions to be extremely turbulent in anticipation of any information as it applies to the bank and monetary policy.

One of the more obvious examples of the Bank of Japan swaying exchange rate valuations occurred during the spring of 2020. In an attempt to manage economic fallout from the novel coronavirus (COVID-19) pandemic, central banks around the world swiftly launched aggressive quantitative easing (QE) programs. The BoJ followed suit, taking dramatic steps to mitigate the negative financial impacts of COVID-19.

In an announcement dated 16 March 2020, the BoJ instituted several QE policies designed to support the Japanese monetary system. Among them were actions centered around increasing the money supply and managing interest rates.^[3]

Increasing The Money Supply

The BoJ pledged to "provide more ample yen funds by making use of active purchases of Japanese government bonds (JGBs) and other operations." The "other operations" consisted of issuing collateralised loans on corporate debt, extending credit to current BoJ account holders, and executing large-scale corporate bond purchases.^[3]

Also, the BoJ decided to begin purchasing exchange-traded funds (ETFs) and real estate investment trusts (J-REITs). Each of these activities was intended to promote market liquidity through supplying ample cash to embattled funds, investors and corporate interests.

Managing Interest Rates

In an attempt to promote economic activity during the contagion, the BoJ decided to hold firm with its Quantitative and Qualitative Monetary Easing (QQE) program. This entailed holding short-term interest rates at -0.1% and the longer term 10-year JGB rate around 0%.^[3]

To further boost market liquidity, specifically with respect to the USD, the BoJ participated in a globally-coordinated 0.25% rate cut. The rate cut was executed in concert with the Bank of Canada, Bank of England, the European Central Bank, Swiss National Bank and the U.S. Federal Reserve. The BoJ also pledged to directly enhance the domestic supply of U.S. dollars. USDs were offered to borrowers on a weekly basis with 84-day maturities, and this was in addition to the existing 1-week maturities.^[3]

QE Brings Volatility To The Yen

The BoJ's QE program became public during the Monday, 16 March 2020 forex session. On 16 March, the JPY posted a wide bullish trading range against the majors. Although the BoJ's QE plan was aggressive, the yen held on to its conventional safe-haven currency status.

For the 16 March 2020 session, heavy volatility was the rule across the majors. Ultimately, the JPY proved formidable as forex participants weighed the potential impacts of BoJ QE and the COVID-19 contagion. Below are the highlights of the yen's 16 March post-BoJ performance:

**JPY is listed as the base currency to ease comparisons, gains/losses approximate

• JPY/USD: The yen rallied vs the U.S. dollar, gaining 2.02% for the session.
• JPY/EUR: Forex traders favored the yen over the euro, with JPY/EUR rates ticking north by 1.27%.
• JPY/GBP: Rates of the JPY/GBP moved higher by 2.06%.
• JPY/CHF: The yen performed well versus the Swiss franc, gaining 1.39% on the day.
• JPY/AUD: A strong intraday uptrend led to a 3.24% gain by the yen against the Australian dollar.
• JPY/CAD: Tanking crude oil prices hurt the Canadian dollar and contributed to a 3.44% session rally in the JPY/CAD.
• JPY/NZD: Yen values strengthened against the New Zealand dollar by 2.43%.

Note: Past performance is not an indicator of future results.

The 16 March 2020 forex session is a premier example of how BoJ policy can bring heavy volatility to the yen. On this day, currency traders and investors preferred the JPY over all other global majors.

In the midst of the COVID-19 outbreak, the BoJ's QE program was widely viewed as being better-positioned to achieve its goals than those of the FED, ECB, or BoE. As a result, the JPY functioned as a short-term safe-haven from coronavirus angst.

Intraday Volatility

Several economic indicators can cause short-term exchange rate fluctuations concerning the yen upon their release to the public. Data reports such as the Consumer Price Index (CPI), Gross Domestic Product (GDP), Merchandise Trade, and Industrial Production can have dramatic pricing effects upon the yen immediately after they are released to the public. Unique to Japan is the release of its bank's "Tankan" survey. The survey is considered to be the most complete report of Japan's economic health and is released quarterly. It measures economic output as it pertains to capital expenditure on a sectorial basis.

An individual release of the Tankan survey can be a good illustration of how intraday volatility concerning the yen's foreign exchange rates can be immediately influenced. Due to the fact that the Tankan is released ahead of the quarterly GDP report, it can be seen as a leading indicator of GDP. In economically challenging periods for the nation's economy, the survey can carry a tremendous amount of weight in the decision making of investors.

While past performance is no indication of future results, following the July 2, 2007 release of the Tankan survey, there was an immediate depreciation of the yen as it pertained to the United States dollar and euro, simultaneously. USD/JPY traded up immediately to 123.28 from a low of 123.15, while EUR/JPY spiked to near all-time highs at 166.75.^[4]

During a time of uncertainty in the Japanese economy, the Tankan release attracted the attention of both long-term investors and short-term day traders attempting to gain perspective on the economic health of Japan. Upon the survey's immediate digestion, volatility facing the yen increased. Ultimately, the yen was universally devalued against other major global currencies.

Fundamental Volatility Drivers

Japan imports 99% of its oil and a large percentage of its total energy. Not surprisingly, the yen can be extremely sensitive to commodity pricing.^[5] A prime example of the yen's volatility increasing on an intermediate term basis is the relationship that the exchange rates of the yen have in regards to crude oil pricing.

Japan's dependence on fossil fuels as an energy source has increased dramatically in the years following the catastrophic Tohoku earthquake in 2011, subsequent tsunami and resulting nuclear reactor meltdown at Fukushima. Accordingly, the availability of cheaper crude oil has been welcome for Japan's economic health. This dependence would suggest an inverse correlation between the yen and the pricing of crude oil futures. This means that the yen would logically be expected to increase in value if crude oil decreases in value.

As mentioned, past performance is no indication of future results, but on December 15, 2015, during an extended period which saw WTI crude oil futures slide from US$100 per barrel in August 2014 to US$50 per barrel in January 2015, the yen made big gains during a dramatic downturn in crude oil pricing. As crude oil plummeted 4% to a near five-year low, the yen gained 1.2% vs the US dollar, and .6% vs the euro.^[6]