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The Japanese yen is having the worst losing streak in almost 50 years and fell to a 20-year low of 130 against the US dollar recently. A weak yen is likely to spell trouble for the Japanese economy (look at Venezuela), however, the government is keen on keeping its monetary easing policy in place in favour of spurring growth.
There have been demands for the Bank of Japan to raise interest rates, but the central bank aims to use the weak yen to achieve its goal of reflation in the Japanese economy. It sees company profits swelling with a weak yen as exports become competitive, but what about the domestic economy which is not exposed to exports?
Weak yen and policy intervention
Japan’s Finance Minister Shunichi Suzuki in April said that the damage to the economy from a weakening yen is greater than the benefits it poses, which is contrary to Central bank Governor Haruhiko Kuroda’s stand of ‘patiently continuing monetary easing.’ The central bank also intends to maintain its 0% yield target for 10-year bonds, widening the gap with the US yield spread.
Trouble started brewing when the US Federal Reserve announced rate hikes early this year, and the US dollar strengthened against the yen. The concern remains whether the yen would depreciate further as the US Fed has plans for aggressive rate hikes for the rest of the year.
“FX intervention cannot be justified on macro fundamentals. As for FX forecasts, USD/JPY is already at our forecast high of 130 and we will be minded to revise the profile higher given it looks like the dollar can stay strong/strengthen further over the next three to six months,” writes Min Joo Kang, Senior Economist at ING, adding that the bank expects an FX intervention if USD/JPY moves closer to 135.
Earlier in April when the central bank kept key rates steady, Japan’s ex-Forex chief Hiroshi Watanabe told Bloomberg that 135 levels are not so critically bad for the economy, but “how long it’s going to stay there is quite important”.
What is Japan playing at?
Japan’s economy contracted 0.2% during the first quarter of 2022, slower than the official expectation of a 0.3% quarterly decline. This is the third straight quarter in which the Japanese economy has contracted. The Russian invasion of Ukraine has increased the prices of oil and food, which pose a problem when combined with a weak yen. Prime Minister Fumio Kishida’s government has approved a $21 bn fiscal spending program that includes gasoline subsidies and cash handouts to low-income families to tide over the inflationary pressures.
However, inflation is what the central bank wants with a target of 2%, as it looks to emerge from 30 years of near-zero inflation in 2022.
“A return to moderate inflation could be a lasting tailwind behind corporate profitability, particularly for the many small- and mid-cap “hidden gems” that combine sound fundamentals, strong competitive positions and pricing power with a growing willingness to address their material environmental, social and governance challenges and engage on corporate governance, capital management and sustainability reforms,” says Neuberger Berman.
While certain companies stand to benefit from this policy, especially the ones with high exposure to foreign markets, can it spur innovation and boost wages in Japan? This remains to be seen.
Generally, consumption picks up if inflation rises in anticipation of higher prices in the future, but the Japanese practice of ‘kakeibo’ – a household budgeting system that preaches cutting back on spending – could prove deflationary for the economy.
“Although a weak yen has been profitable for many Japanese firms and their trading partners, a further depreciation would be harmful. It will not increase exports of goods or key services such as tourism. It would also limit any potential increase in employment at a time when Japan needs more high-quality jobs,” writes Willem Thorbecke, Senior Fellow at the Research Institute of Economy, Trade and Industry, Japan. “Further depreciation would reduce the purchasing power of firms and consumers, and hinder their ability to import key products.”
How should investors approach the weak yen?
“We believe the Japanese market can offer valuable geographical diversification within a portfolio and access to a number of unique companies without true competitors. The Japanese market has also been the beneficiary of rising profitability and an increased focus on shareholder returns and corporate governance,” said Franklin Templeton in a note. Does a weak yen bode well for investors?
Earlier this month, Goldman Sachs said that a weak yen could prove an ideal hedge against the risk of a US recession. “In other words, the yen is now trading at historically cheap levels and screens as the cheapest safe-haven asset by far—at a time when global recession risk is on the rise,” Goldman analysts, led by Karen Reichgott Fishman, write in a research note.
