The Yen's Relation to the Macroeconomic Climate
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Recently, the Japanese yen has been significantly weakened, especially against the dollar. The dollar/yen has been rising since February and is hovering at an 11-month high of ¥83.71, a level not seen since April 2011. In fact, the dollar/yen has soared from approximately ¥76 in February to current levels, a move which has been noted as the "best one-way trade of the year."
There are a plethora of reasons for the weakening of the yen. For one, the Bank of Japan has taken significant measures to undercut the strength of the yen at the behest of Japanese exporters, which had been significantly affected by the strength of the yen in 2011 and early 2012. On February 14, the BOJ initiated an aggressive round of quantitative easing, boosting asset purchases by 10 trillion yen and pledging to keep ultra-easy policy until a 1 percent inflation goal is in sight. Moreover, yen investors were also steered away by the severity of Japan's recent deficit reports: the trade deficit widened in January to ¥1.382T ($17.0B), a figure which is up 245.9% YOY. Japan's current account deficit totaled ¥437.3B for the same month, larger than the ¥322.4B expected by economists. As Richard Hastings, a macro strategist at Global Hunter Securities, notes, "the yen is continuing its weaker trend against the U.S. dollar primarily due to rumblings about long-term debt fundamentals in Japan, and due to the (Bank of Japan) monetary policy action."
However, the weakening yen is also an indicator of the improving macroeconomic climate. The yen has long been considered a bastion of stability in times of crises by investors, as shown by its stratospheric rise in 2011 proportional to the worsening of the European sovereign debt crisis. The lessening of investor demand for the yen can be attributed to the increase in investor confidence as positive developments continue to come out of hotspots such as Europe. Greece was able to prevent a messy default through activation of its collective-action clauses and the initiation of the disbursement of bailout funds. Italian sovereign debt continue to show significant improvement as yields on bills continue to decline; the 10-Year bond yield has decreased from a high of 7.16% in mid-January to 4.90% as of Tuesday. Moreover, on the U.S. domestic front, there are encouraging signs of at least a cautious investor optimism. The S&P 500 Volatility Index (NYSEMKT: VIXM) is at 5-year lows while the S&P 500 recently broke 1,400 and has edged within 10 percent of its historic closing high. One of the major events of last week, the Federal Reserve's first-ever release of CCRA stress test results to the public, also contributed to market optimism, with 15 of the 19 banking/holding institutions participating passing the stress test. There isn't that much negative news out there, as Randy Frederick, director of trading and derivatives at the Schwab Center for Financial Research, notes.
In the past, investor appetite for the yen was driven by the stability of the currency combined with the instability of the world economy, a mix which neutralized multiple rounds of quantitative easing by the Bank of Japan. For example, during the October 31 Bank of Japan intervention the dollar/yen rate was boosted to 79.55, only to plummet to 77.8 within hours. Shortly afterwards, the dollar/yen rate fell to the lowest levels since the intervention, highlighting the investor appetite for the yen in times of economic uncertainty. However, as Japan transitions to an account deficit not experienced in decades and as investors grow increasingly optimistic of investing in other securities, there is not sufficient investor demand to buoy the yen, especially after the Bank of Japan's indication it will pursue more aggressive quantitative easing. This development only emphasizes the lack of traction the yen is able to gain as investors allocate more funds once stored in the yen into other financial securities. The inverse relationship between the strength of the Japanese yen and the strength of the world economy and investor confidence is currently in full display.
The recent weakening of the yen may be far from over. The Japanese government continues to face immense pressure from Japanese multinational corporations such as Nissan (NASDAQOTH: NSANY.PK), Toyota (NYSE: TM) and Mazda as well as organizations such as the Japan Automobile Manufacturers Association to continue to weaken the yen. There has always been pressure from Japanese exporters for significant government action, but the difference this time is the combination of strengthened macroeconomic factors and a weakened Japanese economy, a combination which not only has pressured the Japanese government to initiate increasingly aggressive measures, but in and of themselves have led to the dissipation of the widespread demand for the yen among investors. Expect the best one-way trade of the year to continue as long as investor confidence in Europe and the U.S. continues to rise.
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