TOKYO – It’s been a number of years since Japan Inc lost sleep over the yen exchange rate. Say what you will about Shinzo Abe’s reform regimen, but the prime minister kept the peace in currency circles.
As Abe heads for the exit, markets are buzzing about a stronger yen – a yen that tests the psychologically-loaded 100-yen-to-the-dollar level.
That could be an unspeakable blow to business confidence at a moment when Asia’s No 2 economy is springing multiple leaks. Japanese output is expected to have contracted by an annualized 21% or more in the April-June quarter.
Now, corporate Japan must brace itself and face up to a trifecta of reasons that suggest a stronger yen is on the cards. These three reasons are Abe’s departure, a US election going off the rails and the sudden arrival of one of the globe’s most celebrated value investors in Tokyo markets.
Abe’s departure after nearly eight years in office has strategist Nicholas Smith of CLSA Japan warning clients that 100-yen-to-the-dollar is on the way, from 106 now.
That might not sound like a colossal move. But once the 100 level is breached, market technicals would take over and accelerate the move toward an even higher exchange rate that slams exports.
There are a couple of risks here. As Abe leaves the premiership in mid-September, questions abound about whether the Bank of Japan governor that he hired in 2013, Haruhiko Kuroda, might stage his own exit.
Or, as a new national leader takes over, Might Kuroda opt to rethink the BOJ’s policies?
Deflationary forces are returning. In the best of times over the last seven-plus years, inflation never even moved close to the BOJ’s 2% inflation target. Wages never staged the sizable, generalized increases Abe pledged.
Gross domestic product (GDP) is now smaller than when Abe and Kuroda arrived on the scene.
Reboot, anyone?
Kuroda is “very much Abe’s man,” Smith says, raising questions about how long he might stay on. No BOJ governor ever served two full five-year terms and Kuroda is now into term two. Moreover, Smith points out, “massive money printing is now neither effective nor sustainable.”
So Kuroda might see a new government as a chance for a reset of BOJ stimulus efforts. Any move by Kuroda to, say, recalibrate the mix of assets the BOJ is buying to stimulate growth might boost the yen.
White House wild card
The Donald Trump factor is its own wildcard. As far back as the 1980s, when he was a property mogul, Trump has been railing against Japan.
Ironically, Trump for a time owned Manhattan’s Plaza Hotel, the site of history’s most audacious currency pact. That 1985 deal to weaken the dollar versus the yen still stands in Trump’s mind as a model of American financial influence, one he’s made no secret of wanting to deploy anew to gain a trade advantage over China.
The question is whether Trump, between now and the November 3 election, will announce a broad dollar revaluation. Trump is desperate both to appear strong on the world stage and secure a pre-election win for exporters in the manufacturing states he needs votes from to remain in power.
There are other ways a weaker dollar might materialize, wrecking the rest of Japan Inc’s year. One is a fresh and massive round of dollar printing by the Federal Reserve. The other is jockeying ahead of the US election.
“All is still to play for politically, but the risk of regime change is likely to weigh on the dollar ahead of November’s election,” said analyst Will Denyer or Gavekal Research.
China’s yuan is already experiencing upward pressure. But Trump would want a significant upward revaluation from Beijing for which the Art of the Deal president could take credit.
Warren wades in
The third force that could boost the yen is Warren Buffett.
It’s interesting that the “Sage of Omaha” chose three days after Abe announced he’s quitting to unveil a US$6 billion investment in five old-economy trading houses – the so-called sogo shosha trading giants, some of which date back a century or more.
They long existed as middlemen to procure the natural resources and goods needed to fuel Japan’s post-war boom and help deliver Japanese exports overseas. In more recent years, they diversified into apparel, food, machinery and financial services.
It’s been many years since global punters bet big on Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo, never mind grabbing a 5% stake in each. And Buffett hints he might double those stakes at some point.
Not surprisingly, Tokyo stocks surged this week. The expectation is that copycats will zoom Japan’s way to find their own undervalued, cash-rich and low-risk Japan Inc icons. Those inflows will add fuel to the yen’s advance.
“This is a continuation of Buffett spreading his international wings,” says analyst Stephen Innes of online forex trader AxiCorp. He adds that with a series of recent bets, Buffett “may be diversifying away from the US dollar.”
Last month, Buffett tantalized investors by wagering on gold when he took a notable position in miner Barrick Gold. This, like a massive bet on Japanese trading houses, suggests Buffett is hedging against sizable risk.
That risk could certainly be a dollar plunge that destabilizes US debt and New York’s stock bourses.
Buffett, after all, has been selling pretty aggressively in the US – about $11 billion of stocks in the first six months of 2020. The stakes Berkshire sold include JPMorgan and Wells Fargo.
It also has been selling blocks of carriers like American Airlines, Delta Air Lines, Southeast Airlines and United Airlines.
Either way, the spread between US and Japanese yields is widening, with Japan’s edging higher while America’s dips. This, notes Taizo Ishida, a portfolio manager at Matthews Asia, is normally a telltale sign that the yen will be heading higher.
Whatever success Abenomics had was the result of a double-digit yen decline.
Recent business confidence surveys, including the BOJ’s closely-watched Tankan, have delivered the worst readings since at least the 2008 global financial crisis. Worries about a stronger yen that hurts export competitiveness and crimps profits are set to weigh on investment decisions.
In the April-July quarter, Japan’s corporations saw current profits almost cut in half as roughly 20% of sales disappeared amid the pandemic, the Finance Ministry said this week. That was the biggest drop since the “Lehman shock” 12 years ago.
Sales have now dropped four quarters in a row. The April-June period saw current profits drop by 47%. This trajectory will get even worse as this trifecta of factors drives the yen higher at what is essentially the worst possible moment for Japan Inc.