Lost in translation: yen weakness enters new phase

By:
Peter Garnham
Published on:

The reaction in the currency markets to comments from Japan’s new economy minister shows that the recent weakening trend in the yen is entering a new phase.

After months of riding a consistent and profitable downward path, investors should get ready for more volatile price action.

The yen strengthened sharply after Akira Amari, Japan’s recently installed minister for economic revival, appeared to declare victory in his government’s attempt to weaken its currency.

USDJPY dropped a big figure from ¥89.60 to ¥88.60 after newswires quoted Amari saying that the “yen is correcting in line with fundamentals” and underlined the harmful effects on Japanese people’s livelihoods likely to result from a spike in import prices if the currency weakened excessively.

Still, this is hardly news and certainly not a turnaround in policy from a government that has consistently aired its desire to weaken its currency in a bid to stimulate its economy.

Arguably, the comments could reflect the realization in Japan its policy of talking down the yen is going to come under increased scrutiny from its international partners.

Just last week, regional Federal Reserve president James Bullard said he was a “little disturbed” that Japan seems to be taking a more explicit exchange rate policy. Meanwhile, Kim Choong-soo, governor of the Bank of Korea, said on Monday the bank might have to take action to counter the impact of the weak yen on Korean exports.

Indeed, according to Bank of Tokyo-Mitsubishi UFJ’s long-term valuation models, after its recent sell-off, the yen’s overvaluation has almost fully corrected. That would imply increasing international opposition should Tokyo attempt to engineer a further sharp depreciation in its currency.

However, the truth is that the reaction to Amari’s comments are probably a reflection of market positioning and a realization that after a sustained sell-off, the recent one-way nature of price action in the yen has come to an end, rather than any shift in policy from Tokyo.

After all, EURJPY has risen 25% since mid-2012, and at ¥119 stands above its four-year average. USDJPY has climbed almost 15% in three months and stands just above its five-year average. Furthermore, the yen’s real exchange rate has fallen 15% since the middle of last year and is now 10% below the 10-year average.

As Michael Derks, chief strategist at FxPro, puts it, after that dramatic readjustment it could be contended that the yen is now close to fair value.

Furthermore, short yen positions have quickly become the overwhelming consensus in the market.

Short yen positions at extreme levels 
 

 

According to figures from the Commodity Futures Trading Commission, speculators on the CME built up the largest short positions in the yen for five and a half years in December, and those positions remain close to record levels.

With positions at such extremes, investors are going to need increasing reassurance that the trend in yen weakness will continue. Any suggestion to the contrary from Japanese officials, however unintentional, will send them rushing to take some profits.

“The shorts need a good shake-out, because the various rationales for currency weakness in Japan are in danger of becoming stale and tired,” says Derks. “We can expect that the yen will be much more volatile than we were used to through 2011 and most of 2012.”

Japanese policymakers will have to tread carefully if they want to keep the yen on a downward path. It might be a while before we hear Amari pontificating on yen strength again.