The Invesco CurrencyShares Japanese Yen Trust ETF (FXY), which tracks the Japanese yen against the US dollar, has declined by about 7.85% from its 52-week high in March 2018. The divergence in monetary policy between the two nations has been one of the main drivers of the direction of the ETF, as the Bank of Japan (BOJ) has embarked on extremely loose monetary policy conditions for an extended period of time now. Amid the dovish shift of the US Federal Reserve, this article assesses the outlook for FXY.
(Source: Yahoo Finance)
The ETF tracks the value of the yen against the US dollar. The strategy does not involve the use of derivatives, but simply involves buying yen using US dollars. Consequently, the holdings of the fund do not include any futures or options, but simply consist of cash held in yen. The annual net expense ratio of the ETF is 0.40%.
Risk note: The Trustee will sell yen held by the Trust to pay Trust expenses, if any, incurred in USD, irrespective of then current yen prices. The Trust is not actively managed, and no attempt will be made to buy or sell yen to protect against or to take advantage of fluctuations in the price of the yen. Consequently, if the Trust incurs expenses in USD, the Trust’s yen may be sold at a time when the yen price is low, resulting in a negative effect on the value of the shares.
The reason I have distinctively chosen this particular ETF is due to the fact that it is the only one that offers non-leveraged exposure to the yen. Furthermore, according to data from ETFdb.com, it is the fund with the largest level of Assets Under Management, and also has the highest average daily trading volume, thereby offering the best liquidity.
Mixed economic data
The Nikkei manufacturing PMI for November came in at 52.2, which beat the consensus estimate of 51.8. Positive economic data would reduce the need for more monetary policy stimulus from the BOJ. However, it should be noted that Japan’s manufacturing PMI has actually been on a declining trend for most of this year, as shown by the chart below.
(Source: Trading Economics)
Furthermore, consumer confidence has also been weakening, which came in at 42.9 for November, missing the consensus estimate of 43.3. For a nation that is already battling low inflation and sluggish demand, a weak consumer confidence report is rather concerning. In fact, inflation is currently still at 1%. While this is better than the negative inflation rate that the country has experienced in the past, it is still well below the target rate of 2%. Therefore, the economic conditions of Japan certainly do not allow for the BOJ to ease its stimulus programs anytime soon, which will continue to weigh down the Japanese yen, and consequently, FXY.
Safe haven buying supports the currency
The Japanese yen is considered a safe haven asset, which tends to perform well during times of increased market volatility and uncertainty. In fact, FXY was rallying during the October market turmoil, and global macro issues such as Brexit and US-China trade war fears have also supported buying in the currency.
However, this is not a strong case to buy into the fund, as the trade dispute has caused the global economy to slow down, particularly China, which Japan depends on to export goods to and support economic growth. Nevertheless, the worsening economic performance in China will continue to drag Japan’s economy down as well, which will inhibit the Japanese yen and FXY from rallying.
More monetary policy stimulus plans
Amid the global economic slowdown, and the weakening Japanese economy as a result, the BOJ is considering additional monetary policy measures to support the economy. The current short-term interest rate is already at -0.1%. The governor of Bank of Japan, Haruhiko Kuroda, has suggested that potential future monetary policy tools involve further lowering interest rates and increasing its bond purchasing program. The fact that the BOJ has to consider further loosening monetary policy conditions is definitely not a bullish sign for the Japanese yen and FXY. Therefore, I certainly do not recommend buying into the ETF at the moment.
Dovish US Federal Reserve
The US Fed has recently turned more dovish amid slowing economic growth, which could potentially weaken the USD against the yen. However, investors should keep in mind that any dovishness in US monetary policy due to slowing global economic growth will very likely be accompanied by looser monetary policy conditions from the BOJ, which in turn would weaken the yen against the USD. Therefore, over the long term, FXY is not likely to benefit from a dovish Fed as a result of synchronized weakening global economic conditions.
Even after the 7.85% decline in FXY, I would not recommend buying long positions in the fund - especially given the fact that Japan’s economy continues to weaken, which may induce further monetary policy loosening by the BOJ, causing the yen to plummet.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.