Is the yen now the world's premier safe haven?
The yen has long been seen as one of the principal safe-haven currencies, and in a world where US politicians flirt with dollar default, some view it as the world’s premier safe haven.
However, does its traditional role as safe haven guarantee that this role will continue? Although the yen has attracted risk-averse capital throughout its lost decade, some believe its mounting problems are set to turn former currency relationships on their head.
“To believe yen is a safe haven is to believe the Japanese economy has no problems: to think that you must be blind,” says Jerome Lorenzi, FX portfolio manager at LNG Capital.
“The majority of its energy must be imported, it has an ageing population and a debt almost as large as the US. People say it has a high domestic savings rate, but that is the only positive it has.”
In recent months, sentiment on Japan has been improving. The Bank of Japan (BoJ) has loosened its monetary policy aggressively, with an ambitious plan to double the money supply in a 12-month period, which started this spring. This makes the BoJ’s planned monetary policy markedly looser than those of the other big central banks in the medium term.
“We have probably already seen the shock effect of this on yen,” says Ilya Spivak, currency strategist at DailyFX. “It will be a bit quieter now, but yen should continue to structurally weaken towards the end of this year and next, assuming the worst does not happen with the US.”
If the Japanese turnaround continues and inflation expectations are met under the BoJ’s easing policy, the BoJ will probably increase rates, undermining the yen’s value as a carry trade play, says Taku Arai, product manager for Japanese equities at Schroders. However, he notes that, for all the interest in Abenomics, the US is a bigger driver on yen than internal Japanese politics.
Most people agree the yen is likely to follow a downward path in coming months. The question is how far the government will let it fall. While a weak yen is good for Japanese exporters, it hurts the economy as a whole because the country is a large importer of energy. If dollar-yen hits around 110 or 120, the ministry of finance would probably tackle the situation, Arai reckons.
LNG’s Lorenzi agrees 110 is the short-term target, but sees the move going much further in the long term. “Japan needs dollar-yen to be around 150 in the long term,” he says, as the country seeks to regain competitiveness in a neighbourhood dominated by countries with cheaper workforces and weaker currencies.
Soaring energy costs will be offset by rising wages, he predicts, adding: “They need hyperinflation to erase that debt; there is no other way.”
In the near term, the biggest risk of yen appreciation comes from traders continuing to view yen as a safe haven, and fleeing there as risk aversion sets in, particularly if political brinksmanship returns in the US.
Although the US Congress has kicked the debt ceiling can down the road, there remains a strong possibility of further drama in the new year, clouding the outlook for yen in 2014.
In that scenario, DailyFX’s Spivak sees yen strengthening as the global carry trade is unwound. “If there is another major drop in market confidence, [carry trades] will be unwound to some extent, which necessarily means that people will cover their JPY shorts and the currency will rise,” he says.
Lorenzi believes this outcome is likely, with yen weakening considerably against commodity currencies, such as the Aussie and Kiwi, Canadian dollar and Norwegian krone.
There are plenty of other factors for Japan-watchers to consider as the government rolls out Abenomics. Recently the debate around planned increases in the sales tax has been particularly lively, with BoJ governor Haruhiko Kuroda expressing the belief that the economy could withstand a doubling of the tax to 10%.
The decision to go ahead with an initial rise to 8% from next April was eventually made at the beginning of this month.
Many observers, including the IMF, see such a tax hike as an essential precondition to meeting Japan’s fiscal challenges, but the issue remains politically charged and the Japanese cabinet is divided on whether – and how – to implement further rises.
These debates have been set against a relatively upbeat mood in the Japanese stock market, though the weakening yen has been bad news for non-Japanese investors in the Nikkei, with returns eroded in dollar terms.
“When investing in Japan equity, investors obviously had to hedge away the inherent currency risk,” says Frank Jensen, CIO at Origo Asset Management. Failing to do so for a USD-based investor would have halved returns for 2012, he says.
However, hedge funds and others have been able to play the Japan-reflation theme, “mainly long Nikkei and short Japanese yen holdings”, says Anthony Lawler, portfolio manager at GAM, the fund of hedge funds manager.
If the yen weakens or even stays at around its current level, it will benefit manufacturers, particularly exporters, says Schroders’ Arai. Those sectors have underperformed in the past two to three years, notably before the Abenomics rally started, relative to sectors driven by domestic consumption, such as retail and telecoms.
Conversely, those sectors that have done well until now have a greater exposure to the tax rises. Valuations of manufacturers therefore look more attractive, says Arai.