The yen has risen 1.3% against an unweighted basket of other G10 currencies so far this year.

When we say that the pairs are trading badly, we don’t necessarily mean that they are falling; indeed, both have mostly risen this year against other G10 currencies. Instead, what we mean is that they are trading poorly relative to how we might have expected them to trade in light of the incoming information; specifically, Russia’s invasion of Ukraine. We would have expected both currencies to have been a lot stronger than they are now given what’s happened, and, in that sense, we’d argue that they are underperforming. The yen has risen 1.3% against an unweighted basket of other G10 currencies so far this year, while the dollar is up 1.7%. Hardly significant rallies given the currency's supposed safe-haven status and the catastrophe that is unfolding in Ukraine. We can remember numerous times in the past when such seismic shocks would have created much more strength in these currencies. So, what’s going on, and does this ‘underperformance’ tell us anything about how the pair might trade in the future when (hopefully) the war in Ukraine is far behind us?

For the yen, we clearly have to point out that Japan is heavily dependent on energy imports and that the surge in prices is bound to have had some adverse effect on the yen via its trade implications. However, there are two points to counter this.

The first is that this surge in energy prices, plus the ongoing rise in prices created by the supply-chain difficulties arising from Covid, has arguably put the possibility of BoJ rate hikes in the frame for the first time in many years. This in itself might have been thought of as sufficient to galvanise the yen bulls.

The second is that these safe-haven effects that lift the yen in times of crisis are usually so dominant that they crush other influences, such as the weaker trade outlook arising from higher energy prices. One explanation for the yen’s poor response could be positioning. We are used to the yen being used as a significant funding currency for the carry trade, such that major risk-off events, like the war in Ukraine, prompt a surge in the yen as investors ditch their carry trades and buy back the funding currency. It might be the case that the prevalence of the yen carry trade is not what it was in the past. G10 interest rates have certainly compressed to Japanese-like levels since the financial crisis and even more during COVID, and this might have reduced the attraction of the carry trade. The same could be true when it comes to the dollar, which could possibly explain why the greenback’s response to the war in Ukraine has been a rather lackadaisical one. Here we can’t fall back on the argument about the adverse trade impact of rising oil prices that we used for the yen.

What’s more, we’d also argue that this is not the first time recently that the dollar has rather underwhelmed. The surge in the dollar we saw in reaction to the initial outbreak of the pandemic in early 2020 was sharp, but over in a flash, and most of 2020 saw the dollar falling, not rising, even though the pandemic continued to rage. We have noted in the past that the provisioning of dollar liquidity via central bank swaps and repos might have convinced traders and investors that they don’t have to scramble for dollars whenever a crisis hits. Other central banks also have similar facilities, such as the ECB. Hence, this whole idea of a flight to safety might be redundant. If that’s the case, then we think it does impart a negative bias on funding currencies such as the yen and the dollar. For if prior strength in these currencies was due in part to isolated bouts of extreme risk aversion and rapid carry-trade unwinds, the apparent absence of such influences going forward would imply that these currencies should be weaker on average than they were when carry-trading was more dominant.