2009 August | You Are The Worst dot Com

There was big news in the forex this week with a shift in Japan from a current account surplus to a deficit. It has been 13 years since this has happened and it does present changes that forex traders should be thinking about.

The current account is also known as an economy’s trade balance. If you have a surplus trade balance it means the economy is exporting more than it is importing. The Japanese traditionally have a surplus while the US has had a large deficit for decades.

The current account is one half of the balance of payments. The balance of payments measures all capital and trade flows in and out of an economy. The other half of the balance of payments is the capital account. The capital account should be nearly the mirror image of the current account and therefore “balances” the trade surplus or deficit.

Because the U.S. sustains a large current account (trade) deficit it has a large capital account surplus. The capital account tracks all changes in asset ownership. For example, the U.S. “finances” its current account deficit by selling debt. The transfer of that ownership in debt is tracked in the capital account. The balance of payment in Japan works similarly.

Now that you know what the balance of payments is and how the current account or trade deficit fits within that measure, you can start to apply that information to the trend on the USD/JPY. If exports continue to drop in Japan and the deficit grows, demand for the JPY should weaken. The deficit also creates problems for economic growth in Japan, which should also weaken the JPY.

If you know that the fundamentals are aligning themselves in favor of a weaker JPY you know what direction the USD/JPY or other JPY forex crosses are likely to trend in the near term. Take the chart below as a good example of this application. The JPY has strengthened a few times over the last few weeks and each time has bounced back up from the 23.6% retracement support level.

Daily Chart of USD/JPY
Balance of Trade

The USD/JPY is at the 23.6% retracement level again and may be lining up for an interesting buy opportunity. A move up from this level could extend all the way to the neckline of 2008’s head and shoulders pattern near 105.00. Aligning fundamentals with technicals like this can help forecast the near term trend.