During the first quarter of this year, the U.S. Dollar was able to gain ground versus most major currencies. While it gained only a moderate 2% versus the Euro, it was up more than 10% versus the Yen. Over a period of six months, USD/JPY is up almost 15%. This has been a very strong and unusual move and clearly also had an impact on the whole FX market. AUD and NZD continue to hold up well against the U.S. Dollar and have, after a brief period of weakness, shown some strong momentum in the past few weeks.
Change of monetary / fiscal policy and its effect on the JPY
The weakness of the Yen is understandable considering the current situation in Japan. Recent developments there, including fiscal and monetary policy decisions, are now commonly referred as "Abenomics", in reference to the new prime minister of Japan, Shinzo Abe. For more than 20 years, Japan has been stuck in an economic situation with little to no growth, low inflation and low interest rates. In recent years, the stronger Yen added even more pressure on the export dependent economy. Now Japan looks to implement a rather aggressive policy change under new prime minister Abe. The new strategy includes a broad range of measures such as inflation targeting (2% target rate), big scale quantitative easing and expansion of public spending. Short-term, these measures will increase the deficit, but the hope is that increased economic activity and growth will eventually help to narrow and eliminate the deficit. While from an economist's point of view these measures seem questionable, they clearly had the desired impact on the Yen. Also, these measures are understandable considering the recent policies in the European Union or in the U.S.
(Chart showing: Capital flow to equities, trading volume and hedge premiums for JPY)
From an investment point of view, we are asking ourselves another question. What impact did the massive JPY selling have on other currencies, especially USD/JPY? While some investors attribute the recent recovery in the U.S. Dollar to improving economic fundamentals, we are of the opinion that the recent massive liquidity flood from Yen to U.S. Dollar acted as a strong support for the Dollar. The ongoing budget crisis in the U.S. has not been a major event for global markets recently, but it is a problem that is still unsolved and sooner or later the debt problem in the U.S. will become the focus of attention again. That is also the reason why we continue to be cautious on U.S. Dollar investment exposures and continue to be short the Dollar. With the Yen trade normalizing in coming weeks and the global picture to become more resilient, we feel that the outlook for USD and EUR remains negative.
Based on our current strategy, we continue to be mainly positioned in so called "second tier" currencies such as AUD, SGD, NOK, NZD just to name a few. Currencies of countries that we feel are fundamentally healthy (or less sick) and we see a continued trend towards currency diversification away from USD, EUR and JPY.