The yen is weighing when the bulk of the world’s central banks have already jumped on the bandwagon of tightening in the face of inflation from bygone times. In particular, it hurts the notorious divergence with the US Federal Reserve, which has been raising rates since spring and has telegraphed more increases, its officials talking about rates at 4% for a long time. Quite the opposite of a Japanese central bank that has maintained a negative interest rate of 0.1% since 2016 and that continues to buy public debt without limits to keep the yield of the 10-year bond around zero. The reflection is
In times of turbulence, uncertainty and crisis, there is some controversy when looking for the reasons that make (rather made) the yen a strong asset in times of weakness, but most experts agree that investors seek refuge in the Japanese currency due to its long history of controlling inflation and because the Japanese themselves repatriate a good part of their most liquid investments when they are badly given globally. These luxury inflows of capital used to strengthen the yen against its peers.
For example, in the 2007-2008 crisis, the yen acted as a safe haven for a long time. Beyond the appreciations at the beginning of the turmoil, the yen strengthened by around 60% against the dollar between mid-2007 and 2012. Also in the dot-com crisis and even in the covid crisis in 2020, despite the fact that Japan was geographically much closer to China (the epicenter of the pandemic), the entry of capital flows appreciated the yen against the dollar at the most critical moments.
However, the yen seems to have lost its ‘magic’, that safe haven status. The Japanese currency has lost more than 20% against the dollar in the last year. What’s more, the yen has lost more than 6% against the euro, despite the fact that the single currency is also experiencing low moments. Japan is going against the grain on monetary policy, which has opened up a gap in the rate differential (interest rates) that is punishing the yen. On the other hand, there is the commercial component. (imports more than exports) which also works against the yen.
A divergent monetary policy
“As for the US/Japan story, the Fed and the BoJ are as far apart as you can get. and promises to do more. The BoJ is one of the few dovish central banks (recently joined by the People’s Bank of China). Still practicing quantitative easing. In practice, this means that holding a deposit of $3 million pays 3% per year. If you have a deposit of 3 million yen, you still charge 0.10% per pleasure. This over 3% rate differential really raises the bar for the yen to perform better as a safe haven,” said Chris Turner, Chief Market Strategist at ING.
The expert believes that “if US equities fell enough for the Fed’s tightening cycle to appreciate substantially (and we haven’t seen much of that this year), the yen would outperform again and the dollar would fall”. “I also suspect that the dollar/yen (USD/JPY) cross is moving into a zone where Japanese policymakers will show more obvious concern: they stepped in to sell USD/JPY at these levels in the late 1990s. “, Add.
Turner warns that it is a long way from the 80s to weaken the dollar. “This would require the Fed to cut rates (very unlikely this year) or the BoJ to raise rates (also unlikely). So, as things are going this year, one cannot rule out a movement towards 150 yen per dollar”, he adds.
“Interest rate expectations continue to dictate the mood in currency markets and we expect the greenback -as a less dirty shirt- to remain firm over the coming months,” agrees Javier Corominas, Director of Global Macro Strategy at Oxford Economics. The expert points out that macro volatility is no longer a driver for the yen and that, with no prospect of a short-term rebound in yields and a moderate decline in commodity prices, investors will continue to shy away from the yen. “Declining global and global yields will be a catalyst for yen strength, but that’s a 2023 story,” he notes.
Trade balance and yen/dollar exchange rate
Corominas seems clear that the yen is a bargain right now, but he doesn’t see a catalyst for it to rise. While acknowledging that the scope for further depreciation is limited beyond the BoJ’s policy on its target of keeping the 10-year yield in check, he concludes that they cannot yet position themselves bullish on the yen, unless an appreciation takes place. significant and material downward trend in energy prices from here leading to an improvement in the trade balance.
Apart from the real factors, the expert emphasizes the fundamental role that financial factors are playing in this decline of the yen. The recent weakening of the positive historical correlation between Japanese investment exposure abroad and currency hedging has been key.
“We have not seen a dramatic increase in returns from hedging Japanese overseas exposures relative to previous bouts of yen weakness, particularly 2012-14. We believe this gap has been caused by changing perceptions of yen Japanese investors regarding the decrease in the safe haven status of the yen in the face of this global supply shock,” added Corominas.
acknowledged some of these trends in its latest forecast report: “In the foreign exchange markets, the yen has depreciated against the US dollar, mainly the differing direction of monetary policy between the two countries (Japan and the US) and the purchase of dollars by Japanese importers. The yen has also depreciated against the euro, reflecting a rise in interest rates in European economies,” the central bank stated.
The deterioration of the trade balance
The war in Ukraine and supply problems to keep up with demand have caused a drastic rise in energy prices and some of the inputs with which the Japanese industry works. ING experts explain that “since Japan imports all of its energy from fossil fuels, the terms of trade (the prices Japan receives for its exports versus what it pays for its imports) from Japan have collapsed.”
This has had a notable impact on Japan’s trade flows, rather than price flows. Last summer, Japan earned 6 trillion yen a year from international trade (trade balance surplus). In the past 12 months, that trade surplus has turned into a 6 trillion yen deficit on rising energy bills. “In general, a safe-haven currency must be backed by a strong trade surplus, so that there is a natural demand for a currency in a crisis. The yen has lost that support,” ING experts say.
From Oxford Economics they agree with this theory and affirm that “we cannot go back to being bullish on the yen, unless we see a significant and material downward trend in energy prices that leads to an improvement in the trade balance” .
A surplus in the trade balance allows the agents of that country to enjoy an increase in their income. Creditor countries (in balance of payment terms) produce more than they consume, which allows them to generate this ‘extra’ income that comes from abroad in exchange for the goods and services sold. In addition, current account surpluses per se push up the local currency exchange rate, since to import goods and services from the country with a surplus one needs to buy its currency. A Japanese game console factory will sell its products abroad in yen, and even if it sells them in another currency at some point it will have to exchange it for yen to pay its workers, electricity, other costs or to distribute the profits (dividends) among its owners .
As is happening in the Eurozone, under current global conditions, the weakness of the yen is working against the Japanese economy, at least in the short term. The marked energy nature of the current crisis is generating current account deficits in regions that have posted recurring surpluses. Added to the rise in the price of energy is the appreciation of the dollar, which makes energy imports more expensive in relative terms for countries that do not have the ‘green ticket’ as their official currency.
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