This year's performance in assets tied to the Japanese yen has been dismal. Back in April I issued a sell recommendation on the yen, which has been largely validated as the CurrencyShares Japanese Yen Trust ETF (FXY -0.15%) has fallen by nearly 14% so far this year. But even with this weakness, there is little to suggest that we have seen the bottom in the currency. Key divergences in monetary policy can be seen when looking at the initiatives proposed by several major central banks, and this has created differentials in bond yields that have reached multiyear highs. All of this points to continued downside in the yen, as the Bank of Japan is committed to pushing forward with monetary easing as a way of supporting the outlook for export companies and normalizing consumer inflation levels back toward its 2% target.
When compared to the ETFs tied to the world's 16 most commonly traded currencies, the CurrencyShares Japanese Yen Trust ETF has posted the second worst yearly performance relative to the PowerShares DB US Dollar Index Bullish ETF (UUP 0.04%), which tracks the value of the U.S. currency. Japan's historic bond-purchasing program is still in its infancy, however, and since the Federal Reserve is still expected to announce cutbacks in stimulus much sooner than any other developed-market central bank, this is a trend that should continue well into next year. This outlook is supported by bond yield differentials in 10-year Treasury notes in the U.S. and Japan, which have widened beyond 2.2% this month -- a premium that has not been seen since April 2011.
Policy divergences not limited to the U.S.
But these divergences in central-bank planning are not unique to the U.S. The Reserve Bank of Australia provides another example of a country that has reversed its previously accommodative stance, and sent signals that the country's economy can continue in its recovery without reducing interest rates. This brightens the outlook for the CurrencyShares Australian Dollar Trust ETF (FXA 0.50%), as it signals a bottom in interest rates (which are already at record lows of 2.5%). Economic data continues to support the RBA's more hawkish stance, as the country's latest GDP figures showed that the economy expanded at a rate higher than analysts had anticipated, growing by 2.6% in the second quarter. Higher interest rates create an additional incentive for long-term investors to hold on to the currency, and this suggests that the CurrencyShares Australian Dollar Trust ETF will outperform most of its counterparts in 2014.
Watch Abe for next direction in the yen
Going forward, continued weakness in the CurrencyShares Japanese Yen Trust ETF will depend on Prime Minister Shinzo Abe's level of aggressiveness with plans to combat decades of deflation in consumer prices. Early next month, markets will see final decisions to either leave sales taxes on hold at 5% or raise them to 8%. Policymakers will also be considering additional stimulus measures, which could include reducing corporate income levies. Changes in either of these areas will essentially imply that the Bank of Japan is committed to injecting stimulus for the long haul and that policy changes could be seen in a variety of different areas. None of this is positive for the yen, and investors with currency exposure should continue to look at assets denominated in the Japanese currency as a sell -- with much more weakness yet to come.
