Yen Strength Creates Large Ripples
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On the heels of the news that China and Japan have agreed to openly trade Yuan and Yen comes the news that China is actively involved in buying up distressed Spanish assets. State Grid Corp. is going to buy high voltage transmission assets in Brazil from Spain’s Actividades de Construccion y Servicios for $938 million. This is just one example of how the deflationary spiral of the European periphery will be a boon to the world’s second largest economy. Land grabbing is going to be a major theme during the resolution of this debt crisis. And both China and Japan are sitting on trillions of U.S. Dollars in reserves to fund their acquisitions.
Internally, in Europe, German companies have been buying up Greek assets for the past few years. And the twin vices of severe austerity and debt repayment that Germany is squeezing the Greeks in is fueling a dangerous type of nationalism that has been simmering below the surface in Greece since the end of World War II. If Germany does not relent and accept at least partial responsibility for the mess, the resolution of which they will benefit most from, then Europe is headed into a new dark age.
Have Yen Will Travel
Since the beginning of March when the statement by FOMC Chairman Ben Bernanke regarding the lack of need for more quantitative easing set off a firestorm in Gold and the commodity complex in general, the Japanese Yen has risen along with the U.S. Dollar versus other currencies as investors flee to the liquidity and relative safety of both currencies. The CurrencyShares Japanese Yen ETF (NYSEMKT: FXY) is up 6.3% since March, which reflects that the Yen is seeing stronger flows than the Dollar. The PowerShares DB US Dollar Index Bullish ETF (NYSEMKT: UUP) has rallied 5.7% since that day and has cleared its January high with a good chance of hitting $24 in the near future.
This is not to say that the fundamentals of either currency have improved. They have not, if anything they have even further deteriorated. But since the current crisis is centered on the Eurozone, by comparison the U.S. and Japan look like the models of fiscal and monetary sanity, the best of a bad bunch.
But, the Yen’s strength has been more secular that just the Dollar. Versus the Euro the Yen is up 12.2% and 8.8% versus the British Pound. With the Swiss Franc pegged to the Euro, the Swiss Franc’s losses mirror the Euro’s. Capital is flowing out of the Singapore dollar as well, which is down versus both the Dollar (4.2%) and the Yen (7.6%).
This massive appreciation of the Yen has made it easier, and quickly, for Japanese companies to invest around the region; much of which is not tracked by the FDI statistics kept by the national governments.
Carry on My Rising Sun
The end of the Dollar – Yen carry trade since the Fed moved to zero-bound interest rates has presented new opportunities around Southeast Asia beyond the nominal carry trade. In Vietnam for the past 2 years, one could play the carry spread between the Dong and the Yen which has been as high at 14%.
As the State Bank of Vietnam has begun easing some of that capital will be incentivized out of the banking sector and into Vietnamese equities which are trading at very attractive valuations. For example, PetroVietnam Fertilizer is trading at a current multiple of 3.8 with a 10% dividend yield. Then there is Societe de Bourbon Tay Ninh, trading at an all-time high, a P/E of 5.8 with a whopping 15% dividend yield.
The VN Index is valued at $30 billion, or 23% of Toyota (NYSE: TM). Even 5% of the money flowing into the Yen would explode valuations in these smaller markets. Companies like this exist all over Vietnam and Southeast Asia and can now get access to capital to take their businesses to the next level from investors looking to park funds to avoid the storm in Europe and the U.S. The real estate markets in Vietnam’s major cities will be prime targets for distressed asset purchase.
Since the beginning of this phase of the global financial markets began, the beginning of March, The Yen and Japanese Government Bonds have actually improved in quality. CDS spreads for 5 year JGB’s are lower now than when this began as opposed to those for U.S. debt (expressed in Euro) which have risen 37%. Yields on both U.S. and Japanese 5 year debt have been cut in half.
The situation in Europe will be temporarily resolved soon and the most likely scenario will be an affirmation of the EU and the Euro causing an unwinding of the fear-based trade that is happening right now. I would expect some snapback on the EUR/JPY cross when that happens as capital flows back into Europe and out of both the Yen and the Dollar. For the Dollar, though, the situation is not as rosy as that will put the U.S.’s deteriorating fiscal and economic conditions in the spotlight and there will likely be a rush out of the Dollar that is faster than the rush back into the Euro and the Yen should continue to benefit from that, especially in light of their new found status as a reserve currency for the ASEAN+3 emerging trading community.
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