Gradual Global Recovery May Hurt the Yen

Includes: FXY, JYN
by: Ralph Shell

Both the Japanese exporters, government ministers and the Bank of Japan officials have been complaining about difficulties caused by the strong yen. For much of the year, the dollar/yen traded higher than 90, facilitating Japanese exports as economies responded to various stimulus plans. Then in May after trading in the mid 90s for a month, the USD began to lose to the yen, reaching a multi year low around 80. Part of the strong yen was the perception that the dollar would be depreciated as the money supply increased. Then as markets often do, the USD started to rally versus the yen once the QEII commenced.

The yen also enjoyed support from speculators, fearful of multiple economic events, who then bought the yen as a "safe haven" during troubled times. Weather the yen is truly a safe haven can be debated, but for a period this was a popular trade for the spec. Without exogenous events to derail the economic recovery, the yen may no longer get support from the safe haven crowd.

There are some other reasons to be suspicious about a robust Japanese recovery and continued yen strength. Dependence on exports to boost activity can be risky. China is now Japan's largest trading partner, and the Chinese inflationary bubble is being cautiously stalked by their economic managers. What are the chances Chinese import demand suffers when the economy chills?

It is unwise to bet on Europe giving a boost to Japanese exports either. There, debt concerns have caused lower bond ratings, higher yields and a lower currency, not the backdrop for expanded demand. For repeating spendthrift offenders, there is a healthy dose of masochistic austerity, which some economists warn will further cause a severe economic contraction.

Japan also has some home grown problems. Reduced tax receipts, far less than expenditures, has resulted a record issuance of debt ¥170T in fiscal 2011. There was ¥44T new debt and ¥114T needed to roll forward previous debt issues. Over 50% of the pension benefits being paid to retired workers requires borrowed money to make these payments in 2011. This was reported in from Finance Minister Noda:

"The government will continue to shoulder 50% of Japan's basic pension benefits in the next fiscal year, government officials said Tuesday, after it explored the possibility of reducing its contribution due to revenue shortfalls. The government is set to tap surplus funds at a state-backed entity for around 1.2 trillion yen to partly finance the 50% contribution ..."

With Japanese 10 year notes yielding only 1.15%, the debt problems are much less severe than some of the rates being paid in Europe, but rates can change.

Nations with excessive debt can muddle through, but it generally takes a young, growing population and rapid economic growth. Japan has neither. In addition to the aging Japanese population, the 2011 FY growth rate in Japan is estimated to be 1.5%. In the U.S. today, the final q/q GDP estimate came in at +2.6%, by comparison. Going forward the U.S. estimates are 3% or more per quarter.

For the past month trade in the USD/JPY has been a dull affair with the trade confined to the 83 to 84.50 range. There are rumors that Japanese exporters may wish to repatriate the yen prior to the end of 2010. Should this market move back toward the 83.20 area, let's try to buy the USD/JPY. An alternative to consider is a long CAD versus the yen in the 82.10 area.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.