April 05, 2011
Posted by: Dave Bhagat
function of economic forecasting is to make astrology look respectable." - John
We have witnessed a series of tragic events in
Japan over the past few weeks. It will take years for the physical scars to heal
and much longer before the emotional damage fades from memory, if in fact it
ever does. To add to its woes, Japan has been stuck in an economic malaise of
historic proportions. Its stock market, the Nikkei, has fallen from a high of
almost 39,000 in early 1990 to a closing level of 9755 on March 31, a decline of
about 75 percent. Real estate prices are at about half their 1990 peak and many
financial institutions remain barely functional. Many feared a similar fate for
the U.S. economy following the financial crisis in 2008-2009, but fortunately
they appear to be wrong; for now. The economy is recovering, albeit at a slow
and uneven pace.
Japan's prospects don't look much better for the next
few years either. China has replaced Japan as the second largest economy in the
world, thanks largely to robust economic growth in China, while Japan
languishes. In addition, Japan has an aging and shrinking population, a deficit
to GDP ratio that has for years been the highest in the developed world (until
we overtook them this year) and a dependence on oil and other commodities that
are surging in price.
Despite these economic woes, the Japanese yen
remains strong. Around the time the Nikkei approached 39,000 in 1990, the yen
stood at 160 yen per dollar. For most of the last five or six months, is has
been in an 80 to 85 range, except for a brief surge to 76.25 in the days
following the earthquake and tsunami. There have been several reasons for yen
strength since the financial crisis began. Here are a few:
- The yen and the
Swiss franc, both low yielding currencies, tend to be safe havens in times of
risk aversion, much like the U.S. dollar. Investors favor higher yielding
emerging market and commodity currencies when optimism is high, but park money
in the yen when they are nervous or uncertain about the economic outlook. Global
risk aversion was the aftermath of the financial crisis and the yen
- Yen interest
rates are amongst the lowest in the world and this has been true for most of the
last two decades, as the Japanese government and central bank have tried in vain
to stimulate economic growth. When global growth slows, like it did in 2008 and
2009, global rates fall as well and the yen's comparative yield disadvantage
decreases, resulting in yen appreciation.
- Finally, when
Japanese investors suffer a financial shock or face uncertainty, they have
historically responded by liquidating foreign assets and repatriating funds to
Japan, to shore up their balance sheets. This clearly happened over the past
couple of years.
As a result of the events of the past couple of years,
forecasters who were negative on Japan's economic prospects and on the yen have
consistently been wrong; they projected yen weakness which never materialized.
The table below shows data from Bloomberg, which polls banks around the world to
get their currency forecasts. These are the median forecasts at various points
in time over the past six months:
on the day
September 30, 2010
December 31, 2010
Febuary 28, 2011
March 17, 2011
March 31, 2011
Source: Bloomberg, SVB
What I find noteworthy is that, although the yen is virtually
unchanged between the end of the third quarter of 2010 and March 31 this year,
with the exception of the blip on March 17 consensus forecasts for both the end
of 2011 and 2012 noticeably shifted in favor of less yen weakness. In other
words, forecasters are not as convinced as they were about the prospects for
material yen weakness in the months and years ahead.
opinion, they have thrown in the towel too early. I believe we are in the
process of forming a base and assuming the 80 level holds, could see significant
yen weakness over the next couple of years. I have summarized my main
fears are overdone: Financial institutions such as life and casualty
insurance companies that face significant additional claims will likely fund
them from claims on government-backed reinsurance companies, by dipping into
retained earnings and by selling their holdings of Japanese Government Bonds
(JGBs). By all accounts, only a minor portion will require the sale of foreign
assets. Pension funds hold significant foreign assets, but unlike the insurance
companies above, the recent tragedies will not impact redemptions. It is, in
fact, possible that recent yen strength and the bounce off the recent lows in
Japanese equities might actually make them underweight foreign assets, perhaps
requiring a top up in those investments, or a sale of the yen. Commercial banks
that face claims are likely to need to sell JGBs, not foreign assets. Like banks
elsewhere in the world, they have become increasingly risk averse over the last
two years and opted to hold most of their reserves in government paper or cash.
Retail investors that face financial difficulties may well need to liquidate
some of their foreign holdings. However, the percentage of those directly
impacted is so low that it is unlikely to move the needle significantly in terms
of market impact, unless there was sudden and coordinated liquidation, which has
not occurred up to this point.
Foreign buyers remain long on Japanese
equities. They rushed in to find bargains after the earthquake and they have
been rewarded by an almost twenty percent surge in the Nikkei. Unless equities
continue to rally significantly, there is likely to be some profit taking,
resulting in money flowing out.
easing: The Bank of Japan (BOJ) is committed to maintaining ample liquidity
and keeping rates low, to support the economy in both the short and medium term.
Any selling pressure in the JGB market — from banks or others — will almost
certainly be met by fresh buying from the BOJ. This virtually unlimited amount
of quantitative easing might boost stocks, but will keep rates low and weaken
- A global
recovery should mean a weaker yen: As the U.S., Europe and other parts of
the world continue to recover, inflation will rise and so will interest rates.
The U.S. employment report last Friday was robust and should add to hopes of a
sustainable recovery here. On the other hand, the BOJ will be forced to keep
rates low and maintain an accommodative monetary policy, which will hurt the
yen. In addition, domestic investors are likely to find more compelling
investment opportunities outside Japan as long as the domestic economy
struggles, leading to more capital outflows, which will pressure the yen.
struggles to emerge from this tragedy, fight a twenty year pattern of subpar
growth and overcome its longer-term secular challenges, easy money and a weak
yen are what the economy needs and what policy makers want. The government's
hands are tied on the fiscal front, given its somewhat precarious deficit
situation and the constant threat of ratings downgrades, leaving easier monetary
policy and a weak yen as their main weapons to boost economic growth and
In my opinion, too great a focus on repatriation flows has
clouded the picture. It is in Japan's interest for the yen to weaken and the
international community appears supportive. If investment and speculative flows
fall into alignment as well as I believe they will, the yen will break above the
85 level shortly, which will generate further selling pressure and a likely move
towards 95 and then 100. A lot of technology companies with un-hedged yen
receivables have benefited significantly from yen strength over the past few
years. That might soon change.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates. Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand and governmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, and only make investment decisions on the basis of your own objectives, experience and resources.
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The Japanese Yen Will Confound Forecasters Yet AgainApril 05, 2011 Posted by: Dave Bhagat
"The only function of economic forecasting is to make astrology look respectable." - John Kenneth Galbraith
We have witnessed a series of tragic events in Japan over the past few weeks. It will take years for the physical scars to heal and much longer before the emotional damage fades from memory, if in fact it ever does. To add to its woes, Japan has been stuck in an economic malaise of historic proportions. Its stock market, the Nikkei, has fallen from a high of almost 39,000 in early 1990 to a closing level of 9755 on March 31, a decline of about 75 percent. Real estate prices are at about half their 1990 peak and many financial institutions remain barely functional. Many feared a similar fate for the U.S. economy following the financial crisis in 2008-2009, but fortunately they appear to be wrong; for now. The economy is recovering, albeit at a slow and uneven pace.
Japan's prospects don't look much better for the next few years either. China has replaced Japan as the second largest economy in the world, thanks largely to robust economic growth in China, while Japan languishes. In addition, Japan has an aging and shrinking population, a deficit to GDP ratio...Read More