March is the end of the fiscal year in Japan, which means that profits earned overseas find their way back to Japanese corporations. Those overseas earnings must be converted back into the yen as exporting manufacturers top up their profits in Tokyo. These flows are real, and the March seasonal factors should boost the yen along with ongoing global risk aversion.
The yen has earned a Jekyll and Hyde type reputation. On the one hand, it suffers from punishingly low interest rates making it the logical short in carry trade strategies (buying the currency of a country offering higher interest rates vs. a currency offering lower rates). Yet it has also appreciated against the dollar, given its appeal as a safe haven in times of economic stress.
It began to appreciate in July 2007 from ¥123 and although the road has been rocky, it has appreciated to ¥85 when risk aversion had its last hurrah in January (see “Safe haven”).
To fully understand this, readers should look at the yen against the euro. The yen’s strengthening vs. the dollar did not simply represent a stronger yen but a growing aversion to the dollar as risk assets became pricier. For example, the euro extended its trek higher against the yen even after July 2007, when the U.S. markets bore the brunt of the selling.
The strength of the yen has become insufferable for its nascent government. At first, they preferred to look at the yen as a barometer of strength in the event that recovery promoted demand for its exports. As the government changed hands in 2009, this was a sea change in ideology in a nation accustomed to obeying the demands of manufacturers wanting to maintain a cheaper currency to promote exports.
But in mid-March, its Prime Minister Hatoyama warned that his government might yet need to act to stem yen strength. “We need to take firm measures against such yen strength,” he said.
The Japanese economy has been asleep for almost two decades. The first decade saw politicians, businesses and bankers ignore the decaying state of loans crippling the Japanese banking system. Only in the new millennium have they tackled sour loans and encouraged massive bank consolidation, allowing for healthier new loan creation.
The Bank of Japan eased policy one more time in December 2008 at the same time the Fed made its final cut of this bear cycle. With virtually no yield, both currencies relied on safe haven status. Only when recovery perceptions are temporarily rejuvenated do the relative inconsistencies of a strengthening yen become apparent.
The typical repatriation scare muscled the yen higher in early March. However, equity prices returned to break even and beyond, which has put the spotlight on two things: The Fed hiking interest rates in 2010 and the struggle Japan is having with deflation as it deals with a stronger currency.
In March, the finance minister once again rattled his saber against currency markets. It’s been six years since the Bank of Japan acted on behalf of the government to stem a rise in the yen, but the nation is running out of options.
Having already allocated a ¥10 trillion fund used to purchase corporate and government assets from the banking system, the resultant expansion remains meager. The Bank of Japan in announcing any further measures to expand this fund also must be prepared to tow the government’s line and push back at a forex market intent on strangling the yen.
Growing risk appetite may start to undermine the path of the yen against the dollar. The early March uptrend in the yen has beaten back far sharper rallies for the dollar. With equity indexes likely to attempt a 10% gain on the year before the rally is done, investors surely will be dissuaded that the yen is a solid long-term bet. The dollar may well weaken vs. the euro into the second quarter, but the shocker will be if the yen appreciates against the dollar.
As the gravity pull fades from the appeal of the yen, investors should expect a mid-March reading of ¥91 to head closer towards ¥100 by the end of the second quarter, hitting levels not seen since April 2009 (see “Yen 100”).
Andrew Wilkinson is senior market analyst at Interactive Brokers Group in Greenwich, CT. The views expressed herein are the personal views of the author and are not intended to reflect the views of Interactive Brokers or any of its affiliated companies.