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Of all the things Prime Minister Shinzo Abe thought might be wrecking Japan’s 2020, a surging yen probably wasn’t among them.
Not that a deadly, growth-killing pandemic seemed on the cards either, but the sudden about-face in exchange rates will make Japan’s recession that much worse. It also is very likely the death knell of Abe’s legacy as an economic change agent.
Abe helped power Japan’s longest expansion since the 1980s with a sharp yen depreciation. Starting in late 2012, he prodded the Bank of Japan and Ministry of Finance to drive the yen down by as much as 30%.
The hope was that giant exporters would share profits with workers, kicking off a consumption boom. Former US President Barack Obama went along, figuring a more vibrant Japan was a plus for global peace and prosperity.
Then came along Donald Trump. Since 2017, the US leader pulled his own Abenomics maneuver: prodding the Federal Reserve to print dollars aggressively. He loosened fiscal policy with an enthusiasm not seen in decades and has threatened to play fast and loose with global exchange rate norms and repaying Washington’s IOUs.
Recently, though, Trump’s erratic behavior has begun to undermine trust in the dollar in more primal ways. His trade war and increasingly belligerent behavior toward China has spooked many investors. And Trump’s shockingly inept handling of the Covid-19 pandemic has officially worked its way into currency circles.
That was never clearer than with the move by Fitch Ratings to downgrade its US debt outlook to “negative” from “stable.” Fitch warned of a “deterioration in the US public finances and the absence of a credible fiscal consolidation plan.” America’s AAA rating is very much at risk.
This dynamic is complicating Tokyo’s deflation battle and darkening Japan Inc’s 2020.
Canon shares plunged more than 13% in a single day to the lowest since 1999 after the camera and printer giant reported its first quarterly loss ever. Nissan Motor shares tanked, too, after the auto giant warned of a US$6.3 billion loss this fiscal year. Ditto for robot maker Fanuc after it telegraphed a more than 56% operating-profit decline.
The common thread between all this red ink is a sudden shift in the yen exchange rate as the dollar loses value. It’s an added headwind as Covid-19 disruptions savage demand. “Optimism for an early economic upturn is quickly fading,” says strategist Norihiro Fujito at Mitsubishi UFJ Morgan Stanley Securities.
It hardly helps that Abe’s economy entered the coronavirus battle on a weak footing. An ill-timed sales tax hike in October resulted in a 7.3% contraction in Japanese growth in the last three months of 2019. Confidence has only weakened from there.
“Abe probably feels jinxed and not focusing on his policy errors that plunged Japan into economic troubles even before the pandemic,” says Jeff Kingston, head of Asian studies at Temple University’s Tokyo campus.
Since then, gross domestic product (GDP) dropped a less severe 2.2%. More recent data, though, point to cratering household sentiment, retail sales and business sentiment.
This fallout was slamming corporate earnings even before the yen began skyrocketing. That is raising alarm bells at the highest levels in Tokyo. “It is as unwelcome a development as anyone could’ve expected,” says one senior BOJ official.
For his part, Japanese Finance Minister Taro Aso describes the yen’s recent rise as “rapid,” signaling concern that a strong currency is an added headwind for Tokyo as the coronavirus fallout hits the economy.
“Stability is important,” Aso says, “so I’m closely monitoring it with a sense of urgency.”
BOJ and Ministry of Finance officials are being careful about uttering the word “intervention.”
They make clear, however, that it’s very much on the list of options. As Kenji Okamura, vice-finance minister for international affairs, put it: “The government and the Bank of Japan will keep a close watch on underlying market and economic trends and tackle as needed.”
Tokyo hasn’t officially intervened in markets since 2011.
That episode came as the yen rallied to record highs in the aftermath of a deadly earthquake, tsunami and nuclear crisis that had Japan’s biggest companies repatriating money to cover losses.
Since then, there have been occasions when Tokyo warned of future actions to cap the yen. The comments of the last 10 days, though, suggest a heightened level of concern.
Any action on the yen could be geopolitically dicey. The slightest whiff of Tokyo moving to weaken the yen would put it on a collision course with Trump’s White House. Trump, of course, has threatened his own moves to weaken the dollar for competitive gain.
Though his Twitter wrath is overwhelmingly reserved for China, he also ropes in Tokyo now and again.
Another hurdle is Abe’s Japan has signed on to a number of G7 communiques pledging not to engage in competitive devaluations. Any effort to cap the yen would have to be done stealthily – and with a measure of political cover.
A case in point is letting the BOJ take the lead. As it floods the markets with liquidity, the BOJ can always claim it’s battling recession.
There’s also a question of coordination. As Japan has learned since 2004, it’s biggest effort to tame the yen in decades, unilateral intervention can be futile. Manipulating global markets is best achieved when G7 members sell or buy a currency in coordinated fashion.
That, finance ministry officials say, is virtually impossible in the Trump era.
The urgency for action depends on the nature of the dollar’s drop, says Chris Turner, head of markets at Dutch bank ING. The two windows through which to view dollar weakness are the mid-1980s and the 2002-2008 period.
The ’80s saw a rather benign, orderly decline. The second was a far more destabilizing period when global punters refused to finance US deficits. Turner’s bet is on the former scenario.
But the risk of the latter scenario occurring can’t be ruled out. “The dam is now starting to break for the dollar,” says Louis Gave of Gavekal Research. “As it breaks, this has the potential to unleash a dramatically different investment environment than the one that prevailed in the past decade.”
Many strategists, including Société Générale’s Kit Juckes, think this month is pivotal. If weakness persists past August, Juckes says, then the longer-term decline about which investors have long buzzed might finally be here.
The surge in gold suggests the bearish-dollar trade is growing in popularity. It’s up more than 30% this year as coronavirus case numbers skyrocket. Bitcoin is enjoying a resurgence, too.
Over the last two years, there’s been a negative correlation between a falling dollar and rising demand for cryptocurrencies. There are very valid reasons to bet against the dollar.
Under Governor Jerome Powell, though, the Federal Reserve has essentially become Trump’s personal ATM. It is pumping titanic waves of cash into bonds, stocks, corporate IOUs and, really, who knows what else.
The Fed is being less than transparent about all the asset classes into which it is pushing its tentacles.
Late last month, Powell signaled there’s lots more coming. The US, he says, faces the most severe downturn “in our lifetime” and that the economy’s direction is “extraordinarily uncertain.”
The dollar’s real problem is a Covid-19 crisis that Trump continues to handle disastrously. Fitch seemed to speak for many when it raised concerns about Washington’s fiscal trajectory. Already, Congress has spent trillions of dollars stabilizing the economy. There is talk of billions more, raising concerns about America’s AAA status.
That would put the dollar’s role as reserve currency in jeopardy as rarely before. Naturally, punters are stepping up the search for viable alternatives. The euro is the most obvious.
Yet turmoil and competition within the eurozone, and the absence of a fiscal union, make it an imperfect safe haven in moments of extreme volatility. The pound has an obvious Brexit problem. The Swiss franc lacks liquidity.
The yuan is the clear monetary unit of the future, but it’s not quite ready for primetime. It’s not fully convertible and Beijing does enjoy toying with capital controls. At the same time, the opacity surrounding the $50 trillion shadow banking industry also makes the yuan a flawed dollar alternative right now.
What of Abe’s yen? It’s surely liquid enough. But with nearly 90% of Japanese government bonds held domestically, overseas investors are limited in terms of investing options. The BOJ hoarding roughly half of outstanding public debt warps trading dynamics.
Tokyo also has a well-earned reputation for being too interventionalist toward the yen, causing trust problems.
Even so, the yen’s problem right now is too much demand that’s making Japanese exporters less competitive. It’s a headwind Japan Inc did not see coming. The $2.2 trillion of coronavirus stimulus Abe threw at Asia’s No 2 economy is proving insufficient to cushion the speed of its downfall.
The yen’s rise also is contributing to a sharp deterioration in business confidence. Last month, a BOJ survey found that CEOs at top manufacturing were the most negative on growth prospects in 11 years.
The BOJ, meantime, has been on a yen-printing tear since 2013. That campaign has yet to revive Japan’s mojo in a self-sustaining way.
More support is needed as Japan experiences something of a second wave of coronavirus infections. Recent earnings from automakers Honda, Mitsubishi and Yamaha all put the strong yen threat on display.
Such gloom has “reminded investors of how serious the viral damage is,” notes strategist Masahiro Ichikawa of Sumitomo Mitsui DS Asset Management.
On Wednesday, BOJ Governor Haruhiko Kuroda warned an economic recovery may be constrained “significantly” if strict public health measures are reinstated to curb Covid-19 cases.
Kuroda repeated his mantra that the BOJ will boost stimulus efforts “without hesitation” if needed. “Despite extremely high uncertainties,” he said, “the Japanese and overseas economies are likely to improve gradually from the second half of this year.”
But, he added, “the pace of improvement is expected to be only moderate, since preventive measures (to contain the virus) will constrain economic activity.”
That dramatizes why yen strength is so unwelcome as 2021 approaches. And why exchange rates are trumping Japan’s best shot at a solid recovery in decades.