The Japanese yen (JPY) weakness was a dominant theme in 2021. What factors may trigger a rally in the currency perceived as a safe haven?
Stocks rallied in 2021, fueled by huge monetary and fiscal stimulus. One of the secondary effects of such a rally is a weaker JPY. Investors view the currency as safe haven, and higher stocks and a weak yen are common in a risk-on environment.
Therefore, if a trader expects a higher JPY, stocks will have a hard time rallying because the risk-on sentiment turns into a risk-off. What may trigger a risk-off environment and, thus, cause the JPY to rally?
Here are three possible events: the US bull market ends, Russia-Ukraine tensions escalate, and the COVID-19 crisis to deepen.
US bull market ends
The US equity markets rallied in 2021 and get ready to close the year near highs. The end of the bull market will trigger the JPY to rally, as per the correlation explained at the start of the article.
Some do not agree, though. One of the most vehement opinions regarding a higher JPY states that the currency cannot appreciate because of the Japanese national debt reaching JPY1.2 quadrillion in public debt.
However, this is mostly domestic debt held by the central bank. What is more important to consider is the fact that households in Japan hold JPY1.9 quadrillion in assets – and rising. Moreover, about JPY10 trillion, or roughly $80 billion, is held abroad in institutions.
A risk-off event may cause a flight to safety, and $80 billion flows out of other assets and into the JPY. The end of the bulls market is such an event.
Russia-Ukraine tensions to escalate
A possible black-swan event for financial markets is an escalation of the conflict between Russia and Ukraine. The United States warned Europe recently about massive Russian troops concentration at the Ukraine border. An invasion of Ukraine may trigger a black-swan event for financial markets and, thus, a stronger JPY.
COVID-19 crisis to deepen
Almost two years into the pandemic, and the virus mutated into numerous variants. The new variant, Omicron, is much more infectious than the previous ones and has already become the dominant one. It is a reminder that the pandemic is not over, and the economic impact is far from over. Therefore, another recession is enough to trigger a flight to safety, and thus, a stronger JPY.
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