Despite many attractive characteristics of forex trading , the foreign exchange market is vast, complicated and ruthlessly competitive. Major banks, trading houses and funds dominate the market and quickly incorporate any new information into the prices. Foreign exchange is not a market for the unprepared or ignorant. To effectively trade foreign currencies on a fundamental basis, traders must be knowledgeable when it comes to the major currencies.
This knowledge should include not only the current economic stats for a country, but also the underpinnings of the respective economies and the special factors that can influence the currencies. In the case of the Japanese yen, it is the Bank of Japan. Like most developed country central banks, the Bank of Japan has a mandate to act in a fashion that encourages growth and minimizes inflation.
The Economy Behind the Yen The Japanese economy has some particular and peculiar attributes that yen traders need to understand. Firstly, despite its size, Japan has been notably lacking in growth since the collapse of its real estate bubble. Writers often refer to a " lost decade " in Japan because of this reason.
Second, Japan is also the oldest major economy in the world and has one of the lowest fertility rates. That suggests an increasingly aging workforce with fewer and fewer younger workers to support the economy through taxation and consumption. Lastly, Japan is also an advanced economy with a well-educated workforce. Although industries like shipbuilding have migrated to countries like South Korea and China, Japan is still a leading manufacturer of consumer electronics, autos and technological components.
This has left Japan with significant exposure to the global economy, but increasing reliance on China as a trade partner. Drivers of the Yen There are several theories that attempt to explain foreign exchange rates. In practice, these models do not work especially well in the real market — real market exchange rates are determined by supply and demand , which includes a variety of market psychology factors. Major economic data includes the release of GDP, retail sales , industrial production, inflation and trade balances.
These come out at regular intervals, and many brokers , as well as many financial information sources like the Wall Street Journal and Bloomberg , make this information freely available. Carry trading refers to borrowing money in a low-interest-rate environment, and then investing that money in higher-yielding assets from other countries. With a stated policy of near-zero interest rates, Japan has long been a major source of capital for that trade.
That also means, though, that talk of higher rates in Japan can send ripples throughout the currency markets. Japan has large trade surpluses, but very large public debt and an aging population.
A large percentage of that debt is held domestically, though, and Japanese investors seem willing to accept low rates of returns. That said, the relative stability of the yen has made it a backup reserve currency for many countries. While Japan has very high debt levels, traders tend to be more comfortable with Japan's debt balance, as so much of it is domestically owned. The Bottom Line Currency rates are notoriously difficult to predict, and most models seldom work for more than brief periods of time.
While economics-based models are seldom useful to short-term traders, economic conditions do shape long-term trends. Japan's strong trade surplus will likely maintain the country's position as a relative safe haven for some time to come, but the aging workforce, persistently low consumer and business confidence, as well as the rising significance of China as an economic rival, do threaten that position.
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