The recent run higher in USD/JPY has reignited the debate about the yen and its safe-haven status. But long before the euro crisis was frustrating euro bears (the euro often ignoring supposed bad news), the yen was proving even more frustrating for those who thought the Japanese currency was a one-way bet south.
It’s certainly true that the yen has been trading less like a safe-haven for some time. The carry argument, by which investors borrow in yen to fund trades in higher-yielding currencies, has been weakening for some time. The correlation between AUD/JPY and the S&P 500 is currently half the average that prevailed through 2010 and 2011 (taken weekly on rolling three-month basis). Of course, there are some Aussie-specific factors that have reduced that correlation (i.e. rate cuts), but even so the same trend is evident against other high-yielding currencies. The similar comparison with the Kiwi showed the correlation down a quarter from the 2010-11 average (from 0.64 to 0.49).
It’s another thing however to suggest that the yen is going to move towards being a structurally weaker currency. Yes, the economy has barely grown over the past ten years and government debt (as a proportion of the economy) is way above levels that have caused eurozone nations to be bailed out. But the real value of the currency has been supported by deflation, together with on-going currency account surpluses (even during the bad times) which has meant that Japan has been the strongest net creditor nation (Japan’s assets held overseas less overseas assets held in Japan) for over 20 years now.
Nearly half Japan’s holding in overseas assets are in debt securities (and mostly non-government), which have performed well over the past couple of years. Given the near-zero return on Japanese debt, it’s not been difficult for overseas asset to outperform. But with these very low government rates overseas, achieving this performance in the future can only happen if the pricing of credit continues to improve at the previous pace or if Japanese investors change their preference for bond investments (unlikely).
There’s also the issue of when the aging population starts to run down assets (as they retire), rather than build them up. This remains an ever present danger for Japan, but one which has not yet come to fruition. But in a world of many uncertainties, aging is one of the great certainties, so we know that Japan’s non-working population will outnumber the working age one by 2050, with the ratio being higher than for any other developed nation from now onwards.
So as is so often the case with FX, the arguments are there - it all depends on the timing or having the appropriate catalyst. For now, that’s looking to be a political one. The current administration appears far more active in applying pressure on the BoJ, the last BoJ meeting being the first with a government minister attending for nine years. There appears to be further pressure on the BoJ to be more aggressive in expanding its balance sheet which has increased a modest 36% vs. the more than 200% of the Fed over the same period. If the BoJ follows through, then the underlying dynamics suggest that the start of the great yen reversal may be upon us. It could be a long ride.
