Japan’s dollar/yen exchange rate is currently facing a higher relative strength than the American dollar as well as the euro, and this could continue into early 2020. The weakness in the yen has forced Japanese monetary policy makers to cut interest rates twice this year.
This move will create an indirect upside for the Japanese economy as exports will improve and with it, an increase in domestic consumer spending. However, the U.S. dollar might rally on the strength of a stronger yen since these currencies are strongly correlated.
If the dollar continues to rally, the next thing on Japan’s list of concerns would be the possibility of the Bank of Japan intervening further to fight the downward pressure on its currency. But then again, it is no longer a free ride. The international financial institutions are looking for increased liquidity at all time lows as they deal with shrinking capital inflows.
A stronger yen would mean a weaker Japanese currency against the euro and therefore a weaker Yen could prove to be a boon for American exporters who have been reduced to coping with steep deflation. In the United States, more items are exported to Japan than to any other country and this is due to lower foreign-exchange rates.
A weaker yen would, therefore, mean that Japan’s consumers will also benefit from the declining value of the yen. Also, if the Japanese central bank lowered the level of its deposit ceiling again it would increase the possibility of additional monetary easing from the US Federal Reserve. So, the situation becomes quite complicated and the Japanese economy would need an effective way to contain risks without provoking a bigger loss than is needed.
A weaker yen also means that American consumers will benefit from an improved exchange rate and hence, more spending. If Japan is looking to stimulate domestic demand through stimulus measures, the question that remains is how the American consumer will be able to avail of this additional purchasing power.
At present, the American consumer is facing a very challenging environment. Between job losses, stagnant wages and rising living costs, the American consumer is looking for a relief from these troubles. However, stimulus measures from the Fed are not helping in this regard and the risks are only growing.
The more that the dollar falls, the greater the risk that the yen and the US dollar will come together at some point and this could lead to a more pronounced dollar appreciation. Indeed, another lesson that we should learn from history is that currencies do not trade independently but rather, they also trade according to the direction of their respective economies.
This means that if the dollar continues to fall, the yen and the US dollar may fall in the same direction. This will mean that the Japanese consumers will face higher inflation and a weaker yen. The fall in inflation will force Japanese firms to delay their purchases in favor of investments that offer better returns.
It is for this reason that we cannot ignore the possibility of a stronger yen or a weaker yen, which would push both the dollar and the yen towards a stronger dollar or a weaker yen. For example, Japanese industrial sales and industrial production are still flat year on year. This could mean that the weak yen will lead to an increase in Japan’s imports of manufactured goods, thereby helping to spur business investment.
It is for this reason that we should not be under the impression that a weaker yen will mean that the dollar will continue to fall. The positive feedback loop, which the Japanese economy has depends entirely on the strength of the US dollar and the weakness of the yen.