A guide to the USD/JPY currency pair

The USD/JPY spot price represents the number of Japanese yen that can be exchanged for a single US dollar. It is one of the most popular currency pairs on the forex market, accounting for around 17 per cent of all trade, and the yen's nature as Asia's most liquid currency makes the exchange rate an important bellwether of economic health in the region.

Traditionally, USD/JPY has been a key instrument of the carry trade, thanks in no small part to interest rates in Japan having been kept low for decades through a prolonged period of economic stagnation. Encouraged by this state of affairs, investors would borrow enormous sums from Japanese banks and buy high-yielding assets elsewhere; so long as the interest rate remained constant, they could expect to turn a tidy profit.

However, the 2008 global financial crisis and ensuing recession put a dampener on this. Asset prices entered a downward spiral, selling pressure mounted and western economies slashed interest rates in an effort to stimulate growth, wiping off various currencies' advantages against the yen. Year on year, the yen added 19 per cent to its value against the greenback.

Today, USD/JPY is more volatile. The health of the two economies and the monetary policies of their central banks continue to weigh on the currency pair, of course. This month alone, the dollar hovered at seven-year highs against its Asian rival after US policymakers announced plans to exit quantitative easing at practically the same time as the Bank of Japan confirmed an expansion to its own stimulus programme. However, another factor that affects the strength of the yen against the dollar is the import and export-driven nature of the Japanese economy.

The economy of Japan

Though its economy is the third-largest in the world in terms of gross domestic product, Japan is a small country with little in the way of natural resources and it relies on imports of oil and raw materials from other nations. Rising prices for commodities can therefore damage the economy and push the value of the yen lower.

In compensation for its dependency on imports, Japan is a major exporter to markets around the world. Automobile and electronic manufacturing are two of the industries for which the nation best known, with Honda, Nissan, Toyota, Canon, Sony and Panasonic among the dozens of household brands whose shares are traded in Tokyo today.

Of course, this reliance also comes with a caveat: when the economies of Japan's trade partners slow down, this translates into a sluggish export market and, in turn, drags down the yen. A strong currency has its drawbacks, too - it reduces repatriated earnings for exporters, which sometimes prompts the Bank of Japan to intervene when the yen rallies out of proportion with its international counterparts.

In 2012, Shinzo Abe was elected Japan's prime minister on the back of his ambitious 'Abenomics' policy framework, which seeks to end the country's two-decade stretch of economic stagnation. This combination of stimulus and reform has helped keep the yen low, with the currency posting a 17.6 per cent decline in value against the dollar last year.

However, recent data out of Japan - particularly the news last week that the country has entered a technical recession - has cast doubt on Abenomics' long-term sustainability. The premiere has called a snap election to cement his grip on power, but forex traders will nonetheless be watching for adjustments to economic policy that may affect the future value of the yen.