Tokyo Silent on Yen's Surge, Nikkei Plunge

Japan’s ministry of finance is the most notorious manipulator of inflation data, and for good reason. Japan’s outstanding public debt is 776 trillion yen ($7.25 trillion), or roughly 147% of gross domestic product, the highest among leading industrialized countries. In order to keep its interest rates and debt service costs low, Tokyo’s uses fuzzy math to calculate it inflation rate, to provide the Bank of Japan with the political cover to peg its overnight loan rate at an abnormally low 0.50 percent.

Japan imports almost all of its oil, or 4.2 mil bpd, and is the world’s third-largest oil consumer after the US and China. Japan runs an industrial economy and is only 40% self sufficient in agricultural commodities, so 60% of its domestic demands for food and agricultural products are imported. Yet Tokyo claims that Japan’s consumer price index is only +0.4% higher from a year ago, by far the lowest on the planet, despite a near doubling of food and energy prices from a year ago.

Japan has an enormous stash of cash, and can easily afford to pay for sharply higher prices for food and energy imports. Japan’s current-account surplus, the widest measure of a country’s financial performance on an international basis, expanded 46% to 2.2 trillion yen ($20.1 billion) in October from a year earlier. Japan’s foreign exchange reserves rose 9% to a record $973 billion last year, and are the world’s second largest behind China’s $1.53 trillion.

Currency traders are attracted to the yen because of Japan’s large external surpluses, but are also discouraged from buying the currency, because of abnormally low interest rates for Japanese bonds. On the flip side, global traders have borrowed $1.2 trillion in Japanese yen at 1% or less, to purchase stocks and commodities on worldwide exchanges, popularly known as the ”yen carry” trade.

Recently, the US dollar has been tumbling against the yen, because the US Treasury’s 2-year note yield has plunged from +394 basis points above the Japanese 2-year yield to as low as +250 bp over the past two months. And in a chain reaction, Japan’s Nikkei-225 plunged to a 26-month low, as key exporters sank on fears of a possible recession in the US market and the surging yen. A weaker dollar will hurt exporter profits earned in the US, when converted back into yen.

Thus, unilateral Fed rate cuts have become a big headache for Tokyo’s financial warlords. Yet Japanese finance officials were surprisingly silent this week, as the dollar fell below 109-yen, previously regarded as the MoF’s red line in the sand, where intervention was expected to defend the dollar. The lack of intervention raises the possibility that Tokyo may have acquiesced to a stronger yen, in order to help dampen the high cost of imported food and energy.

Traders might probe the dollar’s downside, until subtle threats of intervention are sounded out by the MoF. There is also simmering speculation that the BoJ might lower its overnight loan rate to zero percent, after BoJ chief Toshihiko retires in March. The yield of two-year Japanese government bonds fell to 0.60%, just 10 basis points above the overnight call rate target.

A rate cut to zero percent could raise speculation of the BOJ returning to “quantitative easing”, a policy of force-feeding banks with excess cash to kick-start the economy. Annual growth in Japanese bank lending has slowed to +0.1% from a year ago, indicative of an anemic economy. Odds are rising that the world’s second largest economy is slipping into recession, led by weaker exports to the US.

Comments

[Kunst]

Japan is a lot stronger than many people realize. Yes they have a large public debt, but unlike us they have huge currency reserves. They also have a tight, competitive technology sector (unlike financial, where they suck). Japan could well replace the US as the driver of the world economy, even as China maintains the status of worker.

[Toto-13]

SirChartsalot reminds me of SirMixALot, famous DJ from the 80's.
Enough about identities, I have to say that Gary is an insance scientists and his work is actually well-deserved of best respect.
Good to see him here
Rob
WallastonInvestments.c...

[chicbee]

Thank you for this very timely article. I have been buying FXY as a safe haven as the dollar depreciates. This seems to be working to safeguard my portfolio somewhat. I appreciate your clear explanations with lots of charts, so I can visualize what's happening and why.

[Bob Roberts]

Top notch analysis as always, keep it coming. I especially like the supporting charts.

[AlexSinclair]

Japan is competitive. The yen may be higher against the $ but the change against Europe, China, the rest of Asia and most emerging economies is minimal or the yen is actually lower than a year ago. On a trade weighted basis the yen really has not moved much. The real story on yen/$ is a US story and as the weakened US consumer and the rapidly declining housing market will be the story for the next few years. The United States will underperform for some time to come. The yen will rise against the $ as the world comes to realize how serious the decline is in US housing prices and how much of US consumer spending has been equity extraction from housing. Japan's exports to the other parts of the world are growing strongly and Europe is much more dependent upon the US consumer than Japan.
The Case/Shiller index is a lagging indicator. Pricing is being determined more and more by foreclosures and short sales which do not show up in MLS or median pricing. The median price has also been a lagging indicator until recently as the decline in the # of transactions at the bottom end fell faster than those above and it is starting to catch up with the actual declines in both low end and upper end pricing. This is much more than a subprime problem in the big housing markets; it is a prime problem because pricing is off more than 20% (as much as 40% in the weakest areas) in the Southwest and the Southeast. Most of the other larger states are off 10 to 20% and foreclosures are accelerating nationally. Foreclosures exceeded home sales last month in Las Vegas and San Diego County had more notices of default in January than single family home sales. We are a long way from the end of this problem.