After rising more than 20% in 2017, the dollar has fallen in value against a basket of major currencies this year. Inflation and central bank manipulation have also contributed to the depreciation of the greenback, pushing up the cost of imported goods. In the face of these challenges, the yen has rallied.
However, if the dollar continues to fall, the yen will likely fall even more.
In other words, the U.S. dollar is a buyer’s market when it comes to currencies. That means when the dollar weakens, other currencies also tend to strengthen. In the case of the yen, this means the yen will likely rise in value against the greenback as the U.S. dollar retreats. But how will the yen react to the dollar’s decline? Let’s take a look at what could drive the yen higher as the dollar retreats.
The Importance of Yield
At its core, money is a code with which people exchange value. When someone wants to buy a cup of coffee with cash, that person is exchanging dollars for beans. But what happens if the cash doesn’t have a cup of coffee in it? What if it’s just a bag with some beans in it? Well, one thing that people do is use that money as collateral for loans. If the loan has a high interest rate (e.g. 30% or more), they could also call that money their collateral and end up paying interest. This interest is a cost to the lender. If people start to call their loan collateral rather than cash, then lenders will have an easier time making loans against the collateral. This, in turn, will drive up interest rates and the cost of borrowing money.
The Rise of Bonds
In a cash-only economy, bonds, or debt, are the safe, reliable investment. But what happens when someone has to make a large purchase, such as a house, car or business? If that purchase is financed with debt, that purchase also costs more. The rise of bonds in the United States, Japan and other developed economies, as well as the advent of quantitative easing and negative interest rates, has led to a renewed interest in bonds as an investment.
The yield on stocks is closely watched as an indicator of investor interest. When people buy fixed-income securities such as bonds and government-issued bonds, they are actually buying the cash-out option. The interest that bond holders receive is put into a fund that is then invested again to provide higher returns.
Dollar-denominated bonds are safe investments, as inflation makes them less valuable.
The dollar’s relationship with the banks has also come under pressure as U.S. interest rates have climbed and the cost of funding loans has grown. As a result, some banks are seeking higher returns on their assets. That is, they’re seeking to increase their assets, not their equity. This means that banks have increased their reserves against their assets, which may have a negative impact on the value of the dollar.
The Role of the Yen in Japan
In a word, Yen. The yen is the official currency of Japan and is one of the major trading partners of the United States. The relationship between the two has been complicated, to say the least.
From the days of colonial rule until 1945, the United States had a monopoly on trade with Japan. After the attack on Pearl Harbor, however, the United States changed its trade policy and allowed Japanese companies to sell goods in the country. That opened the door for Japanese companies to sell products in the U.S.
The result has been a high-yield investment for both countries—Japan’s massive and diverse manufacturing base. The Yen has outperformed the dollar over the long term, and it’s one of the most attractive investments against which to bet during a trade war.
How Japan Manages its Exchange Rate
At the moment, the value of the yen is roughly par with the dollar. That means the yen is trading at a premium to the greenback of about 0.3%. While that premium will Likely continue, it is not expected to be sustained beyond the next year. After that, the yen will likely weaken against the dollar and other major currencies. In other words, the yen is a buyer’s market when it comes to currencies. That means when the dollar weakens, other currencies also tend to strengthen. In the case of the yen, this means the yen will likely rise in value against the greenback as the U.S. dollar retreats. But how will the yen react to the dollar’s decline? Let’s take a look at what could drive the yen higher as the dollar retreats.