A lot of traders are not comfortable in trading the Japanese currency against the greenback for many reasons, the biggest of which is the apparent complexity of the pair. On the other hand, once the Japanese yen is viewed in terms of US Treasury bonds, notes, and bills, it should become easier to understand.
The USD/JPY in Relation with Treasuries
Traditionally, the USD/JPY has had close ties with the US Treasuries. In a nutshell, the pair weakens when Treasury bonds, notes, and bills rise. So from here it’s quite easy why many others gravitate toward this pair: the United States would never default of its bond obligations. This provides a very secure and safe haven status for the pair. This also naturally makes this allocation a long position.
In addition, when interest rates are going higher during the course of trading and if they are believed to be moving further up in the future, Treasury bond prices will go down. This will pull up the US dollar and, in turn, USD/JPY price. In the latter case, it’s more suitable as a short position
USD/JPY-linked Market Trends
The USD/JPY pair can also tell you something about market risks. Here’s an example: when the market is on a risk-on mode, Treasury bond yields will increase as interest rates fall. Yields can also determine risks, with its inverse correlation to the USD/JPY prices can tell something about a degree of volatility because of the market’s ability to turn quickly when panic takes place.
If suddenly panic or fear hits the market, Treasury bond prices will go up and yields will fall. This also means that the US dollar’s value will go down and the USD/JPY pair will increase. This is due to the yen’s status as the premiere funding currency.
Carry trades have been a huge funding source for investors. For instance, if you sell the USD/JPY pair for US dollars and use those dollars to obtain higher yielding instruments such as Treasury bonds, then you’ll be able to bolster your returns.
In a similar manner, US stock markets also have an inverse relationship with the USD/JPY pair. When stock markets increase, bond prices fall, yields go up and the USD/JPY is typically sold due to the opportunity of higher returns for the risk being assumed.
Short- and long-term investors may want to employ different strategies when it comes to trading the USD/JPY pair. For example, short-term trader may want to monitor two-year Treasury bonds and the stock market, while long-term traders would benefit from paying attention to the 10- and 30-year bond numbers.
Considering the nature of the USD/JPY pair’s correlation to the stock and bond markets, it’s a good idea to monitor the S&P indexes for possible early warnings of change in correlations.
These changes in correlation may take place for a variety of reasons. For instance, if the US issues more debt by sales of Treasury bonds and adds money to the system, bond prices may dilute and have varying effects on the USD/JPY pair.