Yen Undermined as G-7 Combines With Deficits After Hitting Post-War High
The Kobe earthquake in 1995 sparked a 20 percent yen surge in three months. After the latest disaster, world leaders are uniting to ensure a stronger currency doesn’t derail efforts to rebuild the economy as Japanese officials flood the financial system with cash.
While Japan’s currency rose 3.7 percent against the dollar in the six days after the March 11 temblor, it is poised to drop in 2011 by the most in six years, Bloomberg surveys of economists show. Derivatives traders cut wagers on further gains March 18 after Group of Seven nations followed Japan’s lead and sold the yen as it reached a post-World War II high of 76.25 versus the dollar. The currency fell for a second day to trade at 80.99 per dollar at 1:20 p.m. in New York.
The yen appreciated on speculation investors will repatriate assets to fund the estimated 10 trillion yen ($124 billion) needed to rebuild after the nation’s biggest earthquake and the tsunami that followed. Wells Fargo & Co. and Bank of Tokyo-Mitsubishi UFJ Ltd. say the gains will reverse as Bank of Japan Governor Masaaki Shirakawa injects cash into the financial system just as his peers prepare to tighten monetary policy, unlike in 1995 when Germany’s Bundesbank and the Federal Reserve cut interest rates.
“The yen will weaken over time,” said Nick Bennenbroek, head of currency strategy at Wells Fargo, the second most- accurate predictor of the yen against the euro in the six quarters through December, according to data compiled by Bloomberg. “The policy response from the authorities is going to be quite substantial. We have already seen action from Japan and other G-7 countries. We would expect further intervention, at least from Japan.”
The yen rose 1.56 percent to 80.58 per dollar last week and weakened 0.5 percent to 114.31 against the euro. Japan’s currency jumped 1 percent in the week against a group of 10 developed-country currencies tracked by Bloomberg Correlation- Weighted Indexes, trailing the Swiss franc and euro after the intervention.
Bennenbroek expects a decline to 86 in 12 months, while Lee Hardman, a strategist at Bank of Tokyo in London, says it will depreciate to 89 by year-end. The yen will hit 88 this year, down 8 percent for the year, according to the median forecast of economists surveyed by Bloomberg. That would be the biggest annual drop since 2005.
“This is a classic unexpected productivity shock,” said Daniel Ahn, an adjunct fellow at the Council on Foreign Relations in New York. “Japanese growth and demand for money will fall, which should be negative for the yen.”
The 9.0 earthquake and the tsunami that followed on March 11 killed more than 8,400 people, exceeding the 6,400 toll in the 6.8 Kobe quake. The current crisis at two nuclear facilities has disrupted industrial production in Japan and around the world as the supply of parts made in Japan dwindles.
Tokyo-based Sony Corp. (6758) has shut eight plants in Miyagi, Ibaraki and Fukushima prefectures, while Toyota City, Japan- based Toyota Motor Corp. (7203) has said it will keep 21 auto and components plants closed until March 22.
JPMorgan Chase & Co. predicted in a March 18 report that growth in Japan’s economy will slow to 0.9 percent this year from 4 percent in 2010, as industrial production falls 5 percent next quarter.
In the first coordinated action since support for the euro in 2000, Europe’s central banks, the Federal Reserve and the Bank of Canada followed the Bank of Japan’s yen sales on March 18, sending the currency down the most against the dollar since September.
Japan’s unilateral sale of 2.12 trillion yen in September prompted then-U.S. Senate Banking Committee Chairman Christopher Dodd to accuse the nation of breaking international accords. Yen losses after that action, the first since 2004, didn’t last. After sliding 3.26 percent on Sept. 15 to 85.75 against the dollar, the yen resumed its gains in less than a week, strengthening to a 15-year high of 80.22 on Nov. 1.
This time, intervention has more “potential to work,” Alessio de Longis, a New York-based money manager who is part of a team that oversees about $20 billion at Oppenheimer Funds Inc., said in an interview on Bloomberg Television on March 18. “We may get more success on the euro-yen cross because of the cyclical divergence in monetary policy,” he said.
Weakness in the yen may be limited as the nation sells foreign assets and brings the money home to pay for rebuilding, which Barclays Capital said may be as much as 10 trillion yen. Reconstruction after Kobe cost 9.9 trillion yen, equivalent to 2 percent of economic output at the time, Barclays Capital’s Tokyo-based economists Kyohei Morita and Yuichiro Nagai wrote in a March 17 report.
“They will turn to their foreign asset holdings, liquid asset holdings, to get financing,” BlueGold Capital Management LLP Managing Director Stephen Jen said at a conference in London on March 17. “They are wealthy enough to do this on their own. But that means repatriation. So you can have a little bit of temporary coordinated intervention, but I think we’re going to see 75, the low 70s for a while.”
Japan’s fiscal position has deteriorated since 1995. The amount of debt outstanding has risen to 919 trillion yen from less than 350 trillion yen, while its economy has shrunk to $5.07 trillion from $5.25 trillion, according to data compiled by Bloomberg.
Trade Support Threatened
The yen has appreciated because of its export strength even though government finances have weakened and the economy has struggled to avoid deflation. Japan posted a surplus every year since at least 1986 in its current account, the broadest measure of trade.
Unlike the U.S. or the euro region, that means Japan doesn’t rely on foreign capital to finance its budget deficit. Now, even that could be in jeopardy.
“The most significant threat to the yen isn’t the BOJ or JGB issuance,” Jan Loeys, JPMorgan’s chief market strategist, wrote in the firm’s March 18 report in reference to Japanese government bonds. “It is the possible erosion of Japan’s trade surplus, since quake damage will increase demand for some imports and limit exports of others.”
The New York-based bank said in the report it expects the yen to range between 80 and 82 per dollar “for the next few months” and may strengthen to 79 by year-end if the Fed refrains from tightening monetary policy.
Traders trimmed bets on yen gains following G-7 finance ministers and central bank chiefs pledges after a conference call on March 17 to “provide any needed cooperation.” The Bank of Japan decided in a March 14 policy meeting to double its asset-purchase program to 10 trillion yen and kept the benchmark rate in a range of zero to 0.1 percent. It pumped 38 trillion yen last week into the financial system in one-day operations.
The so-called risk reversal rate for one-month options on the dollar versus the yen pulled back from a nine-month high. The rate fell to a 1.0 percentage-point premium in favor of calls granting the right to buy Japan’s currency over puts giving the right to sell, from a nine-month high of 2.5 points a day earlier, showing expectations for a stronger yen are abating. The premium was as small 0.21 percentage point on March 11.
“We will be confronted with a phase of ongoing yen stability, perhaps ongoing moderate strength, but this will be followed in six months plus by a phase of moderate yen weakening when the repatriation is cooling down and there will be an appearance of rate differentials,” said Stefan Keitel, who is responsible for about $200 billion as the chief investment officer at Zurich-based Credit Suisse Group AG.
Interest rates were already moving against the yen before the quake struck, in contrast to 1995 when the U.S. and Germany cut interest rates. The extra yield that investors get from holding German 10-year bunds instead of their Japanese counterparts was 197 basis points, or 1.97 percentage points, last week, approaching the most since January 2010. The spread averaged about 3.42 percentage points in 1995.
European Central Bank President Jean-Claude Trichet has signaled he will raise rates, as early as next month, from 1 percent.
The “joint action by the G-7 -- like four of the five previous bouts of coordinated currency market interventions during the last three decades -- is likely to succeed as it is consistent with future interest rate changes,” Mansoor Mohi- uddin, the Singapore-based chief currency strategist at UBS AG, wrote in a report to clients on March 19. “So investors should forget about yen strength.”
Consumer prices fell in Japan for a 23rd consecutive month in January, declining by 0.2 percent. Inflation in the 17-nation euro area quickened to 2.4 percent in February, the fastest since October 2008 and above the ECB’s 2 percent limit. In the U.S., the consumer-price index increased 0.5 percent last month, the most since June 2009.
Prospects for slower growth also suggest a weaker yen. The economy may expand 1.49 percent this year, trailing a 3.1 percent expansion in the U.S. and 2.6 percent in Germany, Bloomberg economist surveys show. In 1995, the U.S. grew 2.5 percent, 2.4 percent in Japan and 1 percent in Germany.
“Japan’s infrastructure has been significantly damaged, and with the focus on the nuclear situation there hasn’t been much attention paid to the impact on the economy and trade,” said Robert Rennie, chief currency strategist in Sydney at Westpac Banking Corp., Australia’s second-biggest lender. “If the nuclear situation is brought under control, then they will still have a lot of problems with power supplies and that will cause difficulties in a number of industries such as steel, auto parts and technology parts.”
Demand for Japanese assets may wane as investors demand a higher premium while its debt nears what Moody’s Investors Service said was a “tipping point.” The nation’s record public debt will probably increase 5.8 percent to 997.7 trillion yen in the year starting April 1, from a projected 943.1 trillion yen this year, the government said in January.
Government debt may reach 210 percent of GDP in 2012, the highest percentage in the developed world, compared with an estimated 101 percent in the U.S., according to the Organization for Economic Cooperation and Development.
“The recent events will require Japanese policy makers to be even more aggressive than they were before,” Michael Hasenstab, who runs the $49.6 billion Templeton Global Bond Fund in San Mateo, California, said in an interview with Pimm Fox on Bloomberg Television’s ‘Taking Stock’ on March 17. “That should further drive that trend over time for a weaker yen.”
---With assistance from Liz Capo McCormick and Erik Schatzker in New York and Jennifer Ryan in London, Candice Zachariahs and Garfield Reynolds in Sydney, Monami Yui in Tokyo. Editors: Philip Revzin, Robert Burgess.
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