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Yen Weakens Driven by Record Current Account Deficits

Shawn Baldwin Discusses the Yen and the Monetary Policy of “Abenomics”

Yen Weakens Driven by Record Current Account Deficits
Shawn Baldwin at the Bank of Japan Shawn Baldwin Images

Today the Japanese Yen dropped against all major currencies after a short lived rally for the past 3 days, it was weakened by the latest record current account deficit. The yen has weakened significantly due to the Abe administration’s resolve and commitment to fight the deflation that has plagued the country over the last thirty years. These initiatives have been dubbed the “Third Arrow” of the “Abenomics” monetary policy.

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The 592.8 billion yen shortfall was far larger than the median analyst forecast estimates of 368.9 billion yen of 24 economists by Bloomberg, the previous deficit account was 127.9 billion yen in comparison. This deficit is the largest in nearly 30 years, expect it to assist in keeping the currency weak. Japan is an export driven economy and the weakness in the yen, when coupled with the increased demand on energy that was substituted due to the shutdown of the nation’s nuclear plants–has effectively driven up the import costs for the country. Japan is sensitive to oil prices since it is devoid of natural resources and it will be sensitive to energy price volatility in the future. These challenges will be accompanied by a new sales tax in April and the combination of these factors could cause complications in the economic plan.

If confidence begins to wane–it could drive the yen even lower. This phenomenon could cause the country to eventually become a deficit nation that uses funding from foreigners versus the current situation of Japanese investors holding 95% of their country’s investments. The latest economic data clearly outlines this and Cabinet Minister Akiri Akmari, stated this tenet after the economic meeting. This is key because he is responsible for economic revitalization. Particular risks to note are deficit dependency which could create a need for servicing of the enormous debt by the international investing community.

This isn’t the first time we have heard these concerns voiced, after the release of the Bank of Japan’s October minutes, members stated that potential risks to the economy loomed and voiced caution outlining their concerns over future growth. Bank of Japan (BOJ) board member Sayuri Shirai stated that” attention should be paid to the downside risks” along with outlining uncertainty in overseas economies. Despite Haruhiko Kuroda’s attestations to sustain stimulus aggressively.The focus of the central bank was 2% inflation in (2) two years. Due to these policies the yen decreased 13 percent last year alone.

The current account deficit could significantly undermine investor confidence in Japanese Government Bonds (JGB’s). Key measures to observe for Abenomics are real wage increases and export volumes. Most expect that exports will increase mainly due to economic recovery and an increase consumption in the United States. However, Japanese companies must begin to increase wages and prices, this is something that they have shown reticence to do.

Currently, international capital flows of approximately $125 billion in overseas money is invested in Japan, as I stated in the RISE OF THE JAPANESE STOCK MARKET don’t expect the debtor status change overnight or to occur in the immediate future– but it should be on the radar if these trends continue. I participated in a conference in Tokyo and one of the participants of my panel was Jesper Koll, the Managing Director and Head of Japanese Equity Research for JP Morgan. Jesper has been in Japan for over (3) three decades and is an incredibly bright fellow–he hinted at this during our conversation and enlightened me along with the group on this trend. Please see the link to the G1 Global Conference on Monetary Policy of Abenomics

I believe that these events may signal a new range of 100-105. The dollar yen is one of the most widely traded currency pairs in the world and information released by the CFTC shows that short positions have increased by $2.1 billion to over $14.4 billion in last December alone, creating the largest net short position since before the financial crisis.

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Concurrently, the Bank of Japan is seriously considering a two hour extension of the functional operating hours settlement system, this will most likely occur in the beginning of 2016 when the bank revamps it’s settlement system. This will initially affect the commercial banks using the system for interbank transfers–and Japanese firms engaging in business globally. The extension would make the cut off period 9pm Tokyo time making same day settlement possible throughout Asian countries. Another beneficial point of this change is an extension into the London market hours, this will ostensibly create an environment in which Japanese companies and investors can purchase foreign funds using JGB’s as collateral–a market dynamic created by Abenomics that shouldn’t be over looked and will be a key driver.The nation’s economy bought 1.48 trillion yen of dollar bonds while investors in Asia increased holdings of dollar bonds for the fifth consecutive month. Most believe that the BOJ will increase purchases this year. I expect that the BOJ most likely will attempt to push the currency lower in 2014.

From a traders perspective it will pay to be medium term bearish JPY, an additional reason to short the yen are Abe’s comments to China over airspace, these factors will reduce the currency being viewed as a safe haven.

In terms of international investing, Abenomics will have additional benefits as evidenced by the purchase of Jim Beam by Suntory for $16 billion USD including debt. This was was driven by the underlying economics of a weaker currency, as it gives Japanese companies economic incentives to gather higher returns, that then translate to greater profits and currency arbitrage opportunities. Expect to see Japanese focused funds do incredibly well along with exposure to them be highly sought after by institutional investors and super high net worth individuals alike. Get on the train now, it has already left the station and will pick up speed.

Follow me on Twitter @ShawnDBaldwin

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About the author

Shawn D. Baldwin is Chairman of the AIA Group (AIA), an alternative investment and advisory firm based in Chicago

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