Forex GBP & JPY: Two islands drive currency volatility

Forex GBP & JPY: Two islands drive currency volatility

Between the Brexit vote in the UK and the runaway strength of the Japanese yen, forex traders around the world have an exciting summer ahead, largely driven by two islands. 

Japanese yen - Aaron Shumaker CC 2.0 on Flickr
Japanese yen - Aaron Shumaker CC 2.0 on Flickr

A month from now, the people of the United Kingdom may vote to leave the European Union, affecting the euro and the pound. That same week, the Bank of Japan may have announced further easing of its negative interest rates, possibly weakening the yen. The two island nations joined five big ones at the G-7 meeting last weekend, to talk money. 

The G-7 is an interesting group. The world's second-largest economy by GDP, China, isn't a member. It isn't even the 8th member of the G-8. That's Russia, the 12th largest economy by GDP (according to the IMF's April 2016 report). India is also one of the top seven economies, but it's not in the G-7. 

China and India have large GDPs, larger than Italy and Canada. But they don't have a high enough Human Development Index (HDI), meaning too many of their citizens don't have high enough life expectancy, education, and per capita income, to be and do the things we consider a good standard of living. Interestingly, it was Indian economist Nobel laureate Amartya Sen and Pakistani economist Mahbub ul Haq who developed the HDI. 

Russia is only 50th in HDI, behind a number of G-20 countries like Argentina and South Korea, but Russia has a lot of nuclear weapons and that's the main reason the G-7 treats it differently. Only three of the G-7 members have nuclear weapons, since three are former Axis powers from WW2. All but one of the G-7—France, Germany, Italy, Japan, the United Kingdom, and the United States—have at one time or another been called "empires." Even Italy had one. Not the Roman Empire; from the late 19th century through the 1950s Italy had territories in Ethiopia, Somalia, Libya. Canada never had an empire, but was part of the British Empire.

If the G-7 looks like the principal Allied and Axis governments of World War 2, minus the USSR, that's because it is. It reflects the economy established after the war, by the Bretton Woods agreement and other factors. It can help to think of that history when looking at what happens in the British and Japanese economies this summer, as well as how the rest of the world reacts. 

Nadex's parent corporation, IG Group, is based in the UK. Like all UK firms, it has plans in place in the event of an immediate Brexit. You know how you stop shopping for new stuff when you're planning to move? Britain is kind of in that situation, only they aren't sure if they're going to move or not. British exporters and importers don't know if they'll be buying and selling from partners in an economic union or foreign countries they have to make new deals with. We can expect the GBP's price to reflect that basic uncertainty. 

The Bank of Japan lowered interest rates in January with one major purpose: to weaken the yen versus the US dollar and, indirectly, other currencies. They wanted to boost exports and encourage lending and investment, something the government of Shinzo Abe has been trying to do for a long time to fulfill its promise to kickstart an economy recovering from over a decade of stagnation. 

However, another factor complicated their efforts. Japanese companies and investors have substantial offshore assets. They would like to repatriate some of those assets, but when they bring those foreign assets back to Japan, they want to exchange it for as many yen as possible. When the yen was relatively weak in late January, around 120 yen to the dollar, some companies took the opportunity to repatriate. But that triggered strong buying and covering of short positions, driving the yen to less than 110 yen to the dollar. That was the exact opposite of what the BOJ and those companies wanted.

If another easing of interest rates doesn't have the desired effect, Japan might take other steps to intervene and devalue its currency. At the G-7 meeting last weekend, US Treasury Secretary Jack Lew said the rise in the yen was "orderly" and didn't warrant intervention. The G-20 countries agreed in February to avoid devaluations that might trigger other devaluations, but Japan may not feel bound by that. While an actual devaluation looks unlikely, the threat of it and the uncertainty over what, if any effect the BOJ can have, all should make the yen a volatile half of any pair it's in. 

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Image: Aaron Shumaker CC 2.0 on Flickr

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