Is the Yen Now Like Oil at $147?

 |  Includes: EWJ, FXY, JYN
by: Darrel Whitten

While investors around the world were focusing on the new Obama Administration's economic stimulus package, the BOJ was slashing their Japan GDP outlook to minus growth of 1.9% and 2% in FY09 and FY09 respectively, given a "highly uncertain environment" in the global and Japanese economies at present. The forecast is more bearish than the government's forecast of zero growth, and includes deflation in domestic prices until FY2010. This is the worst economic performance in Japan since the 1.5% decline FY1998, heretofore the worst in Japan's postwar history.

The BOJ is now looking for modestly positive GDP growth of +/- 1% in 2010, but private sector economists view this as optimistic, leaning instead toward three years of negative growth for Japan's economy.

The three pillars of the Japanese stock market--i.e., electronics, automobiles and banking, accounting for 10.6%, 8.0% and 9.5% of TSE 1 market cap respectively, have horrible earnings fundamentals. There is more bad earnings news to come in these sectors, and stock prices will remain under pressure from rapidly deteriorating earnings fundamentals. Since exports and production, machinery orders, etc. really began tanking from September~October 2008, Japanese companies have yet to get a handle on dealing with the soaring yen, surging inventories and weak domestic demand. This strongly implies that earnings will be a wipeout at least through the first half of 2009 and more likely for the whole year, judging from the BOJ's scenario.

Japan's own economic stimulus of over JPY40 trillion (8% of GDP) is being virtually ignored, even as the BOJ reluctantly begins using its balance sheet to ensure fund availability to struggling Japanese companies. This is because the success/failure of the US $850 billion package and China's $586 billion package is more relevant to Japan's export-driven GDP growth.

The irony is the soaring yen, an illogical move in light not only of rapidly deteriorating economic fundaments, but also of net investment fund flows out of Japan. According to research by UBS currency strategists in Tokyo, the yen's nominal effective exchange rate appreciated by 32.4 pct in 2008, the largest increase in the floating currency regime that began in 1971. USD/JPY declined 18.9 pct., which is the largest decline since 1987, and GBP/JPY declined 40.2 pct, which is the largest fall since 1958. This appreciation came despite record net fund outflows (portfolio + FDI - trade balance) from Japan in 2008, which reached JPY14.2 trillion and was the largest outflow since data since 1989, when the data first became available.

The culprit appears to be massive yen carry unwinding upwards of JPY20 trillion, by UBS estimates. The question is, how long can this yen carry trade unwinding last?

At JPY80/USD, the yen could be like crude oil at $147/bbl, i.e., extremely overbought. Any return of risk appetite or signs that the yen carry reversal has run its course could send JPY spiraling downward, with a possible trigger being intervention in the currency markets by the BOJ, even though Tim Geithner's (the Obama Administration's new Secretary of Treasury candidate) recent comments were read as a warning to Japan and China not to intervene.

In addition, a meaningful reversal in the yen would trigger at least a short-term rally in Japan's auto and electronic stocks, which discount currency moves real time. This could happen despite expected earnings deficits in these sectors and an overall decline in Nikkei 225 profits of 40% or more in FY2009 to March 2010.

Disclosure: None