Japanese Yen: Still a Safe Haven Currency?

Includes: FXB, FXC, FXE, FXF, FXY, UDN
by: Ralph Shell

The Japanese yen has long been regarded as a safe haven currency. When equities sell off a bit, the yen firms, and the pundits reassure investors that Japan is the place to be. In late October after the yen had traded at 92, the large specs began accumulating a long position in the futures markets that totaled well over 50,000 contracts. They, no doubt, were part of the reason the yen was pushed to a multi-month high, 84.81 versus the dollar, much to the dismay of the Ministry of Finance and the big Japanese exporters. Some government jawboning and meetings with the US Treasury officials gave the appearance of pending intervention and the market stabilized. The rally back to almost 91 was in part due to large spec short covering, but more importantly, an awareness developed that the Japanese economy is a mess and perhaps not deserving of the revered safe haven status.

To combat the tepid recovery of the Japanese economy, an 81B dollar stimulus package was announced last week. Since the Japanese already have a massive deficit, a further expansion of the money supply will accompany the stimulus package. The debt burden of Japan as a percentage of the GNP is already 218%, among the highest in the world, according to the International Monetary Fund.

The current recession has diminished tax receipts, and the increased spending by the stimulus bill will only increase the deficit. Tuesday morning a report confirmed this:

TOKYO -(Dow Jones)- The Japanese central government's primary budget deficit is set to hit a record Y34.204 trillion in the current fiscal year ending March, Parliamentary Secretary of Finance Hiroshi Ogushi said Tuesday.

The amount far exceeds the Y13.1-trillion deficit initially envisioned during the budget-making process late last year, highlighting how rapidly the country's fiscal health is deteriorating due to aggressive government borrowing to pay for measures to boost Japan's weak economic recovery.

It is estimated that the debt service as a per cent of tax revenue now exceeds 50%, and that is with low interest rates. The yield on a 10 year note in Japan is about 1.5%, well under the current 10 year 3.58% yield in the US. With higher rates the debt service on the massive Japanese debt would be impossible. This implies low rates in Japan for an extended period, and makes the yen a leading candidate for the lending currency in the carry trade. Since investors borrow from the cheap lender then sell yen and invest elsewhere, this is bearish on the yen.

Sometimes stories continue long after the facts have changed. The yen looks like anything but a safe haven currency. This is not to say that the dollar has the credentials to reclaim the safe haven trophy, but the dollar has been beaten up and a revisit to the mid nineties does not seem out of the question. As for a safe haven currency, how about the Aussie or the Kiwi, and why are the big traders loading up on the long side of the Mexican peso?

Disclosure: no stock positions