According to a senior Financial Times commentator, “The sharp appreciation of the yen against the dollar, despite negative policy interest rates, reversed the normal currency market laws of gravity.” Did it?

Historically, trend moves in the dollar-yen exchange rate have usually followed changes in the differential between the US and Japanese trade balances, expressed as percentages of their respective GDPs. That is, the yen has tended to strengthen after the Japanese trade balance has improved relative to the US position. The trade balance gap has indeed moved in the yen’s favour since 2014: the Japanese position has swung from a large deficit to a small surplus, while the US deficit has been broadly stable – see first chart.

 
What about the supposed boost to the dollar from a widening US-Japan policy interest rate gap? The wider nominal gap has been more than offset by a rise in US headline consumer price inflation relative to the Japanese level. The “real” policy rate gap, therefore, has moved in favour of the yen since 2014, reinforcing support from relative trade developments – second chart.


The US-Japanese inflation differential is likely to increase further as unwinding energy effects give a larger boost to the US headline rate and the stronger yen suppresses Japanese pressures.

The yen’s rebound, therefore, is consistent with historical “laws of gravity”, contrary to the FT writer’s assertion.