Fear Not

A Yen Above 100? Bet Your Bottom Dollar

Japan's exporters can grow even with a stronger currency.
Photographer: Ralf Hiemisch/Getty Images
BANK OF JAPAN/THE
+1200.00
At Closing, May 21nd
47000.00 JPY

Imagine a world in which the Japanese currency strengthens past the psychologically important level of 100 yen per dollar. It wouldn't be so bad.

With Prime Minister Shinzo Abe's approval rating edging toward July's low, traders are doing a U-turn on their yen bets. Hedge funds are now in favor of a stronger Japanese currency for the first time since last spring, while options traders have $160 billion in put contracts that the yen will rise to 100 or above, $30 billion more than three months ago.

Even perpetual bears are losing patience.

Yen Bears Flee

Traders cut their yen short positions sharply in March

Source: Bloomberg, Commodity Futures Trading Commission

Every year, major companies in Japan negotiate with workers' unions on pay rises. This year, the increase in base was 0.77 percent, data released by the Japanese Trade Union Confederation show.

While that's the biggest gain since Abenomics began in late 2012, one can't help questioning if it's enough to lift inflation from January's 0.9 percent to the targeted 2 percent. Bear in mind that Bank of Japan Governor Haruhiko Kuroda has already floated the idea of starting to exit monetary stimulus around the fiscal year beginning April 2019.

At some point, the BOJ will need to worry about its monetary easing creating instability in Japan's banking system. With net interest margins at less than 1 percent, regional lenders aren't keen to take risks, while the bigger players have turned their attention overseas. As a result, regional banks' capital adequacy ratios have been deteriorating.

Slim Cushion

Bank of Japan's unprecedented monetary easing has weakened regional banks' capital adequacy ratios

Source: Bloomberg, Japan Financial Services Agency

The prospect Abe may not survive the September election is rapidly changing the landscape. If he remains in power, Kuroda may feel compelled -- since Abe gave him the job -- to stay on course with massive monetary expansion, Abenomics' first arrow. Yet Kuroda knows well the detrimental effects of keeping interest rates too low for too long.

Japan is highly cyclical. If the global economy is broadly rebounding -- assuming U.S. President Donald Trump doesn't destroy things with his tariffs -- its exporters can still grow even with a stronger currency. Case in point: The nation's exports rose in February for a 15th consecutive month as the yen strengthened 2.6 percent.

Rollercoaster

Japan Inc.'s earnings are more cyclical and volatile than American companies

Source: Bloomberg

Note: Indexed to 100 as of March 31, 1998.

And the yen's strength really only reflects a weak dollar. Over the past year, the yen has fallen 7.9 percent against the euro and has hardly risen against South Korea's won and Taiwan's dollar. According to Societe Generale SA, in trade-weighted terms, the Japanese currency has appreciated by just 3 percent since the start of 2017.

Depends Where You Stand

The yen has weakened against the euro, won and Taiwanese dollar over the past 12 months

Source: Bloomberg

As the world's largest central banks continue on a tightening bias, will the BOJ be the lone dove? Perhaps, but that doesn't mean yen bulls have anything to fear.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Shuli Ren in Hong Kong at sren38@bloomberg.net

    To contact the editor responsible for this story:
    Katrina Nicholas at knicholas2@bloomberg.net

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