Japanese Yen Strength to Be Short-Lived?
The currency markets did an abrupt shift on Friday, as the dollar turned negative for the first time in a week, giving back most of the gains it had slowly accumulated since last Monday.
But the dominant story in the markets remained the Japanese earthquake and tsunami. My thoughts and prayers certainly go out to the people of Japan. The pictures of the wall of water and debris rolling across the landscape is shocking. And the destruction may not be over, as a couple of nuclear plants are still not under control. As I wrote Friday, the disaster has boosted the Japanese yen (JPY) to trade near its record high. The highest I have seen the yen trade was back in April of ’95 when I worked at Mark Twain Bank and saw the yen trade at 79.75 per dollar. Interestingly, this followed the 6.9 magnitude earthquake that rocked Kobe, Japan in 1995. I heard a couple of reporters using the Kobe earthquake as a basis to predict a sharp appreciation of the yen in the coming months; and I can see why they would make the comparison. The Japanese yen shot up over 20% in 1995 during the three months following the Kobe earthquake, and Friday we saw the yen move up about 1.25% versus the US dollar.
But I still think this appreciation of the yen will be short-lived. Companies and individuals immediately started to repatriate funds back into Japan to help with the rebuilding efforts. This helped push the yen higher on Friday, and we will probably see further appreciation of the yen in the coming days. But the 20% increase we saw in 1995 wasn’t all due to the Kobe quake. Most of this appreciation occurred after Nick Leeson took down Barings Bank. Leeson was a rogue trader who piled up enough leveraged bets to bring down London’s oldest merchant bank. This sent a major shock through the financial markets, and investors rushed to the Japanese yen, which was seen as safe haven.
But today is different. Japan currently has world’s largest public debt burdens, and will undoubtedly need to borrow even more yen in order to rebuild. And the Japanese economy, which looked as if it was just starting to grow, will certainly see a slowdown. Toyota, Sony, Honda, and Mitsubishi have all announced plant shutdowns, with many warning these shutdowns could last a while. These companies have immediately repatriated funds back into the yen, but will probably have to issue additional debt in order to complete the rebuilding efforts. So the markets are going to be swamped with Japanese debt offers in the near future. All of the yen-denominated bonds will ultimately prove to push the value of the yen lower. It gets back to the old fundamental rule of supply and demand. The government and corporations are generating yen by the sale of these bonds, dramatically increasing the amount of Japanese yen trading in the currency markets. With a supply of yen higher, and demand for the low-yielding yen decreasing, the value of the yen will fall.
So in my opinion, investors in the Japanese yen should look to exit over the next few days/weeks. The gains we are seeing right now won’t last. Investors looking to move out of the yen but wanting to keep an Asian exposure should take a look at the Singapore dollar. The Monetary Authority of Singapore will likely allow further currency appreciation in order to cool inflation. The Singapore dollar (SGD) looks to be a good alternative to either the Japanese yen or the Chinese renminbi (CNY) whose central banks are attempting to hold down the value of their currencies instead of letting them appreciate.
Another currency that may be a good alternative is the Indian rupee (INR). While the Singapore dollar is one of the best performers versus the US dollar this year, the Indian rupee has moved lower, and now looks like a bit of a bargain. India’s economy continues to post growth figures that are China-like. Industrial output grew 3.7% YOY in January after a revised 2.5% increase in December. This growth surprised most analysts, who had predicted 2.9% January growth. The higher growth rate should give the central bank a bit more room to raise rates to fight inflation. India’s central bank has raised rates seven times over the past 12 months, and could raise them an eighth time at their meeting this Thursday. Good growth and rising interest rates usually equate to a stronger currency, and the Indian rupee looks like a value right now.
Brazil’s central bank is attempting to fight the markets as investors continue to be attracted to the highest inflation adjusted interest rates in the G-20. Brazil’s government is said to be considering new measures to try and stem the gains in their currency (BRL). Earlier this year Brazil increased a tax on foreign investment in the fixed income markets, and is said to now be considering setting time requirements for foreigners’ stock investments to stay in the country. They have also suggested establishing reserve requirements for foreigners who purchase the Brazilian currency, much like what Thailand did a few years back. These actions, along with threats of further intervention, have held the real down. After moving up over 38% versus the US dollar over the past two years, the Brazilian real has been flat versus the US dollar this year.
Commodity inflation will keep up the pressure on Brazil’s central bank, which will likely have to raise interest rates again in the coming months. As I stated earlier, good growth rates and rising interest rates typically equate to a stronger currency. Brazil’s central bank may be successful in holding down the value of the real in the short run, but central bank intervention is never successful in the longer term.
The euro (EUR) was up a bit versus the US dollar as EU leaders emerged from their meeting with an agreement on a new and improved bailout plan for the region’s most indebted nations. European leaders agreed to widen the scope of the rescue fund and cut the costs of loans to Greece. Ireland wanted cuts to their borrowing costs also, but none were granted. Irish Prime Minister Enda Kenny got into a bit of a spat with French President Nicolas Sarkozy and German Chancellor Angel Merkel over corporate tax rates. Merkel and Sarkozy want to standardize corporate tax rates across Europe, but Kenny pushed back crediting Ireland’s lower corporate tax rate with attracting companies such as Google and Pfizer to Ireland. Kenny’s refusal to agree to higher corporate taxes probably sunk any hope of Ireland getting any reduction in their EU borrowing costs.
From what I have read, the EU agreement is really not much of a change. Officials broadened the size and scope of the bailout fund but refused to buy bonds in the open market or finance buybacks. The onus was placed squarely on the governments who have sought aide, with Greece being the only one getting additional help. The refusal of the EU to buy bonds in the open market was not good news for the ECB, which continues to try and keep rates down by purchasing debt in the open markets.
A separate report released Friday showed that German inflation accelerated to the fastest pace in more than two years on surging energy prices. Inflation in February increased to 2.2% from a 2% rate during the first month of the year. That is the highest rate since October of 2008. All reports indicate that Germany, Europe’s largest economy, is getting stronger. Higher inflation, booming exports, and falling unemployment will likely force the ECB into an interest rate increase as early as next month.
Turning to the US, the data released Friday suggested that the US economic recovery is still on a slow and steady track. US retail sales increased in February by the most in four months, rising 1% and matching the median forecast. Another report showed that business inventories are increasing at a slightly faster rate than expected. But the U of Michigan Confidence index dropped for March, probably due to the rising gasoline prices. Today we do not have any data releases, but tomorrow we will see additional data on manufacturing with the release of the Empire Manufacturing index. Tuesday is going to be a big day for data with the additional releases of the TIC flows, Import price index, and the FOMC rate decision. Wednesday we will get a closer look at inflation with the release of the PPI for February along with some housing data and the current account balance for the fourth quarter of 2010. Thursday is St. Patrick’s Day, and a big day for data here in the US. We will see the CPI numbers for February along with the weekly jobs data, Industrial Production and Capacity Utilization, and finally the leading indicators.
Big week for data here in the US, but the markets will likely stay focused on what is happening in Japan.
To recap… The Japanese yen continues to rise, but for how long? I, for one, don’t think we will see a repeat of 1995… India’s growth continues to surprise on the upside… Brazil is also growing, but the central bank continues to try and hold down appreciation in the real… EU leaders emerged with an agreement, but no real change… Inflation and growth in Germany may force the ECB to raise rates as early as next month, and it will be a busy week for data releases here in the US.