The Japanese Yen surged to an all time high against the dollar yesterday, as the financial markets fight uncertainty of a nuclear fallout in Japan. The euro also fell to low as 106 against the yen. The market stabilized today on expectations for the BOJ to intervene in the market once again and possibly turn around the historic appreciation of the currency.
My expectations are for the BOJ to inject record liquidity in the system. I had expected a second intervention following first one in September, but that was ignored by the bank of Japan as the yen had gone into a sideways pattern and halted its appreciation. Following the earthquake, Japan’s economy is going to take a huge hit as many towns are away into sea. It would be tough for the BOJ to sit on the side while the currency appreciation hurts an already fragile economy.
Japan is dependent on exports. Some of the largest Japanese exporters have been complaining for a while about the stronger yen. As the Japanese currency grows stronger, foreign competitors begin to gain a competitive advantage over Japanese firms. This is one of the reasons the BOJ intervened in the market in the first place. But now the stakes are higher. There is a high possibility that Japans economy can fall into another recession as a result of the earthquake and the tsunami. A stronger currency will just deepen that recession, and further diminish the possibility that Japan will once again see robust growth. Therefore, I feel there is no doubt in the market that the BOJ will continue to intervene (as they did last week) until the trend in the yen turns around. This is not very favorable for bullish traders.
At the same time, Japan’s government sits on 200%+ debt to GDP ratio, a number that will likely sky rocket in the next few quarters. The government is expected to bear majority of the cost of the earthquake, which will force them to take on a significant amount of new debt. At the same time, government revenues will decline substantially as many citizens will not be employed and able to pay taxes following this earthquake, which will again raise the budget shortfall. The Japanese government will also be expected to pick up spending, as the U.S. did following the financial crisis, to keep the economy running. And finally, the real GDP in Japan will most likely plummet. All these outcomes combined will send the debt to GDP ratio soaring, possibly above 250% in the next year or two. This deterioration in fiscal condition will prove to be a significant burden on the Japanese yen, as investor will begin to lose their faith in the currency. Yen has long been considered a safe haven for many investors. With the chain of events that will likely be triggered following this tragedy in Japan, it is likely this will change.
Although in the last article I pointed out the Yen will likely head below 80 ( which it did ), I can’t be too bullish on the currency this point in time. I would rather recommend that investors take the bearish bet through the ETF YCS. It is likely, in my opinion, that the yen will crash in the next few months after the initial flight into the currency has ended.