- The Japanese yen remains far and away the most attractive currency in the developed market space owing to its relatively high and rising real yields.
- USDJPY is likely to trade well below 100 and potentially below 90 over the coming months as the yen acts as a store of value amid widespread global currency debasement.
- After a brief decline, the rolling correlation between the yen and gold has begun to rise again, indicating that the yen is behaving like a fiat currency safe haven.
The Japanese yen remains far and away the most attractive currency in the developed market space owing to its relatively high and rising real yields. USDJPY is likely to trade well below 100 and potentially below 90 over the coming months as the yen acts as a store of value amid widespread global currency debasement. After a brief decline, the correlation between the yen and gold has begun to rise again, indicating that the yen is behaving like a fiat currency safe haven.
Double-Digit Yen Gains Are Highly Likely
Developed market currencies are driven primarily by changes in real interest rates which continue to move in Japan’s favour. Japan’s 10-year real (inflation-linked) government bond yields are now a full percentage point higher than those of the U.S., having moved 150bps in the yen’s favour in just 12 months. The chart below shows how USDJPY tends to closely track real yield spreads, and the latter’s recent plunge suggests the pair should be trading below 90.
Source: Bloomberg, Author’s calculations
Deviations between USDJPY and the fair value level implied by real yield spreads have shown a strong tendency to drive changes in the currency pair over the following two years. The current real yield spread suggests that the yen will see around 15% gains over the next two years. Note that this is higher than the current 11% difference between USDJPY and fair value as the currency pair has shown a tendency to overshoot, following similar periods of undervaluation.
Source: Bloomberg, Author’s calculations
Gold’s Rally Bodes Well For The Yen
We noted in July (see ‘The Yen Remains The Best Of A Bad Bunch‘) that the positive response of gold prices to declining U.S. real interest rates was positive for the Japanese yen. The yen has been closely correlated with gold prices over recent years as the following chart shows and after a brief breakdown, the correlation has risen once again over the past month or so.
XAU, JPYUSD, And 52-Week Rolling Correlation
Source: Bloomberg
If gold continues its rally (as we expect it to) in response to the ongoing decline in real interest rates, Japan’s positive and rising real interest rates should also allow the yen to benefit as a store of value. Indeed, despite all the attempts by the Bank of Japan to debase its currency, inflation and inflation expectations remain in or close to negative territory, keeping real interest rates positive. Of course, this could change should the BOJ take a more aggressive stance regarding trying to generate inflation, but even then the country’s extremely high net international asset position acts as a constant disinflationary force.
