(Bloomberg) – The yen’s fall to its lowest level in 20 years threatens to leave it significantly weaker for years to come, rattling global money flows and undermining Japan’s efforts to get its fragile economy back on track.
The speed of the decline – it fell more than 10% against the dollar in seven weeks – caught policymakers off guard and exposed the divisions between a central bank determined to stoke inflation and a government facing a violent reaction to rising prices.
Currency trading has shifted into high gear as other parts of the financial markets count the costs. Companies have cut sales of yen-denominated bonds they depend on to fund their operations and the yields that Tokyo-listed stocks offer international investors have plunged far into the red in dollar terms.
The sell-off began in earnest around March 10, when the United States recorded the highest inflation in 40 years, raising expectations of the Federal Reserve to hike rates aggressively as the Bank of Japan stands still.
The yen fell further on Thursday, dropping to the key level of 130 against the dollar when Governor Haruhiko Kuroda doubled down on his ultra-easy settings with plans to buy fixed-rate bonds every day to control yields.
But it is also clear that forces beyond interest rate differences have intensified the currency rout. When the Fed began its last bull cycle through the end of 2018, the yen did not experience a comparable decline.
This crisis – which coincided with Russia’s invasion of Ukraine – has prompted global fund managers to question the long-held view of the yen as a safe haven in times of crisis. If they’re right, more money could be directed to places like North America, Europe and China in future crises.
“What sometimes appears to be a short-term move may actually signal a deeper, more essential trend,” said Taku Ito, chief fund manager at Nissay Asset Management Corp. “People say the yen is falling because of interest rate differentials, but that may actually reflect a weakening Japanese economy.
Disease and war
The war in Ukraine and the impact of the coronavirus pandemic have increased the pressure on Japan, exposing an economy that is struggling to regain its strength despite nearly a decade of efforts through Abenomics.
Real gross domestic product will hit 2% this year, but start falling again in 2023, before reaching just 0.8% in 2024, according to Bloomberg Economics. And while consumer price inflation could briefly reach around 2% at some point this year, the BOJ does not see annual inflation reaching that level in the forecast through March 2025.
Rising food and energy prices are increasing the country’s import bill and its trade balance has been in deficit for eight consecutive months. The consumer price index accelerated to 1.2% last month, while an indicator that excludes food and energy costs fell 0.7%.
Consumers who waited for wage increases that never came are unwilling to pay higher prices. The central bank is waiting for domestic demand to pick up and companies serving Japan’s domestic market are caught in the crossfire.
Meanwhile, exporters like Toyota Motor Corp. are seeing rising commodity costs but benefiting less than before from a weaker yen, having increased production abroad as the population shrinks at home.
“The weak economy means that investment won’t flow into Japan and Japanese companies won’t invest domestically,” said Takatoshi Ito, a professor at Japan’s School of International and Public Affairs. ‘Columbia University. “The yen’s movements have not diverged from economic fundamentals.”
His assessment helps explain why Japan has not entered the market to stem the decline by selling dollars against yen, and why it cannot expect any support from its trading partners if it does. Despite more than $1.4 trillion in foreign exchange reserves – a treasure trove second only to China – policymakers have been limited to verbal intervention.
With daily trade of over $6.6 trillion, the foreign exchange market is the largest financial market in the world and too big for Japan to fight on its own with any hope of success.
Indeed, investors may be late in their judgment of the yen rather than being wrong.
An inflation-adjusted measure of the strength of the yen against a basket of currencies shows that it has been in wide decline since the mid-1990s, around the time Japan’s economic bubble burst. It is now at levels not seen half a century ago, when the convertibility of the dollar into gold ended, ushering in a new era for the foreign exchange markets.
“The yen has become such an easy sell target,” said Ayako Sera, market strategist at Sumitomo Mitsui Trust Bank Ltd. she says.
While the average Japanese corporate forecast for the current fiscal year is for the yen at 111.93, Kuroda shows no signs of adjusting monetary policy to address their concerns.
His tolerance for a weak yen is longstanding, as he shied away when he was the finance ministry’s top currency official in 2002 and fell to 135.
Although he approached Finance Minister Shunichi Suzuki in acknowledging that very rapid changes in the currency can have negative effects, Kuroda insisted on Thursday that a weak yen is generally positive for the economy.
He also noted that the cost inflation currently seen – which is linked to rising import costs and a declining currency – is not sustainable and that Japan is not able to allow a normalization of monetary policy.
This contrasts with expectations that the Fed will raise rates by 50 basis points next month and follow with more of the same in June and July.
What Bloomberg Economics says…
“Japan is no longer Asia’s largest economy and a decade has passed since China overtook it in terms of GDP. Prime Minister Fumio Kishida’s new government must make extraordinary structural reform efforts for Japan to increase its growth potential and revive the yen as a safe haven currency in a sustainable manner.
–Yuki Masujima, Economist
Admittedly, Japan’s current account is in surplus and the country remains the world’s largest creditor, which helps the yen even though public debt is two and a half times greater than annual economic output.
“Japan’s structural weaknesses always outweigh the advantages it offers, such as political stability, rule of law and robust markets,” said Matthew Goodman of the Center for Strategic & International Studies, who previously advised the White House on Asia.
The depth and liquidity of the Japanese bond market will continue to help the yen as a safe haven, according to Eswar Prasad, an economist at Cornell University who previously worked at the International Monetary Fund.
“The desire of many reserve managers to diversify away from dollar-denominated assets could help boost the yen’s share slightly in coming years,” Prasad said.
Yet that matters little to many traders right now, who are rushing to keep up with the pace of change.
“These are very unusual times and a lot of old school traders like me are scratching their heads and thinking ‘wow, this is amazing,'” said Brian Gould, head of trading at Capital.com, and a currency of three decades- veteran of the markets. “Selling will continue until there is a massive change in policy or we get central bank intervention.”
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