At a time where all the news looks grim - from awful results that forced Citigroup to cut its dividend, to bad US retail sales figures that deepened recession fears, to the ZEW survey showing German business confidence at a 15-year low (and, we might add, Wednesday’s FT report that confidence in the UK property market has hit its lowest level since the housing crash of the early 1990s) - the “potentially scariest news of all” is the resurgence of the yen, according to John Authers in Wednesday’s Short View column.
Some analysts are more sanguine, predicting the yen’s surge will be temporary. But Authers points out the Japanese currency’s jump on Tuesday to less than Y107 to the dollar - for the first time since June 2005 - broke what Nomura called the trend of “reasonably steady weakening against the dollar that had been happening since 1994″.
This is important, in Authers’ view, because the yen has become a gauge for risk aversion in the markets.
When traders feel confident, they borrow in yen to fund investments elsewhere. This yields easy profits unless the yen suddenly appreciates. A rising yen betokens fear.
Hence its close correlation with the equity indices, and with equity volatility. Share prices fall, and volatility rises, when the yen does well
The yen’s rise has “nothing to do with fundamentals”, notes Authers. Indeed, the Bank of Japan on Tuesday reduced its economic assessments of four of its nine regions and admitted the economy was slowing, reducing the chances of a rate rise.
A strong yen is not good news for anyone — including the Japanese, he warns. Falls this year have left the Nikkei 225 stock index in a bear market, down 23.4 per cent from its high of July last year. Fears that the revived yen will damage exporters have contributed to the damage.
Are there any signs of light?, asks Authers.
The rise in the yen, combined with dramatically bearish surveys of investor sentiment, suggests fear has totally taken over from greed in the markets — a classic contrarian indicator of a time to buy stocks.
The long-awaited capitulation may be under way. Scarily, that is the best reason for optimism.
A different view comes from one of the more plugged-in currency strategists in Tokyo, JPMorgan’s Tohru Sasaki. In a Wednesday note, he counters market speculation that the continued decline in the dollar against the yen may prompt yen-selling intervention from the Japan’s ministry of finance.
Citing four main reasons, he says the probability of MoF intervention is “less than 5 per cent, even if USD/JPY reaches 98, our target level in March 2008″.
We’re not saying we agree with all Sasaki’s points, but more often than not, he reaches the correct conclusions. First, he says, the G7 has urged a “more flexible exchange rate” for China - this would surely make it more difficult for a G7-member country to intervene so easily.
Second, Japan’s MoF stopped intervening in the currency in March 2004.
Since then, USD/JPY declined to 101 on two occasions without the MoF stepping in to intervene in the market. That suggests that Japanese foreign exchange policy has changed significantly since March 2004. We think the main reason for it is pressure from other G7 countries.
Third, notes Sasaki, the MoF would have to finance yen-selling intervention by issuing Financial Bills (FBs), [short-term debt instruments with a maturity of three months]. FBs outstanding ballooned due to massive official intervention in 2003 through 2004. Under Japan’s previous zero-interest rate policy, this vast amount of outstanding FBs was no problem. However, since the end of the BoJ’s zero-interest rate policy (in summer 2006), the MoF has had to pay interest (albeit tiny) to FB holders. While interest payments on FBs are lower than coupon income from foreign reserves, it is too risky for MoF to accumulate further debt to finance foreign reserves, especially while yields on US Treasuries are declining sharply. In addition, he notes, the huge government debt is one of Japan’s biggest problems.
Finally, he says, Japan’s MoF uses its “Foreign Exchange Special Account” when it conducts currency intervention. The Japanese government has 28 special accounts, including the forex account, on top of its general account.
But now, these special accounts are under close public scrutiny because of their relative opacity and vast size, notes Sasaki. The forex special account began exceeding the size general account during the massive intervention of 2003-04, he adds. “If the MoF again conducted intervention, it would attract more close attention” to the forex special account - and “the government and particularly the MoF would probably want to avoid this situation”.
Even if the MoF did intervene, concludes Sasaki, “the scale would be very limited because of above reasons”. Therefore, we continue to believe USD/JPY to break Y100 eventually. But Japanese retail investors are still looking to invest abroad, and once USD/JPY breaks that Y100 level, we think Japanese retail investors are likely to resume their foreign asset investment aggressively.
