Yen's Hidden Strength Lures Macro Group Looking Past Recession

  • $7.7 billion Macro Currency Group sees no further BOJ easing
  • Rising volatility as Fed raises rates may spur yen gains

The Japanese economy’s dalliance with a second recession in as many years is obscuring an underlying strength that’s made the yen a favorite bet at Macro Currency Group.

The fund manager, which oversees more than $7.7 billion, rates a stronger dollar as its highest conviction trade followed by modest wagers on yen gains as the U.S. and Japanese economies reap the benefit of previous fiscal and monetary accommodation. The dollar has climbed against each of its 16 major counterparts since June 30, with the yen close on its heels.

“The dollar will literally rally against everything, the one exception might be the yen,” said Mark Farrington, the London-based managing partner at Macro Currency Group, a unit of Principal Global Investors. Japan’s economy “is performing well and its central bank is still easing monetary policy, but not committing to doing more.”

The world’s third-largest economy contracted in the third quarter, analysts predict, marking its second recession since Prime Minister Shinzo Abe took office in December 2012. Other measures paint a different picture with the unemployment rate near its lowest level since 1997, a gauge of industry indicating seven-straight months of expansion, and companies clocking up record profits. The nation is even making headway on the inflation front.

People can focus on a technical recession, without paying sufficient attention to the fact that this is the normal response of an economy to a consumption tax hike, Farrington said in an interview in Sydney. While GDP has something of a “boom and bust aspect” to it, measures like wage growth and hours worked point to a narrowing output gap, he said.

Profit Trends

“The corporate profit trends with U.S. and Japanese corporates are very consistent,” said Farrington, who is also a portfolio manager. “They show the benefits of the early policy response, the confidence of the corporate leadership and also the relative competitiveness stories.”

Japan has undertaken massive monetary and fiscal stimulus under Abe, boosting exporter profits and stocks as the yen weakened about 30 percent against the dollar. The currency will trade in a range of 4 to 5 percent around the greenback, which was at 122.88 yen as of 2:12 p.m. in Tokyo on Wednesday, and rise against other peers, Farrington said. He doesn’t expect further Bank of Japan easing in this cycle.

“We now trade the Japan story primarily on the capital flow trends,” he said, positioning for weakness when institutional investors are exporting capital at the fiscal half-year and year-end points and remaining neutral or anticipating gains the rest of the time. Japan’s fiscal year starts April 1.

The yen is now entering a period where it may even outpace the dollar amid risks of heightened financial market volatility as prospects increase for the Federal Reserve to raise its benchmark interest rate in December, according to Farrington. The European Central Bank also meets in the final month of 2015, when liquidity is traditionally low, after President Mario Draghi signaled policy makers would consider additional stimulus.

Japan’s currency often strengthens as the Standard & Poor’s 500 Index drops, playing the role of a haven asset due to the nation’s current account surplus. The 60-day correlation between the two climbed to an eight-year high in September amid a rout in equities.

“People are bracing for the Fed liftoff and financial markets are not taking it well so Japanese investors are probably less inclined to export capital,” Farrington said. “You’ll probably see some outsized yen strength from more or less a week after the Fed tightens and any financial market volatility that develops, all the way through to the fiscal year end -- so between then and March.”

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