Guest Commentary: Why we are so very long the yen
Yesterday's surprisingly high Japanese CPI data (only 0.1% deflation YoY) reversed the negative sentiment towards the Japanese yen. As Christopher Vecchio explains, the stronger yen might cause also a fall in all risk-assets.
On Tuesday after the bad Japanese trade balance, we increased our long yen against the euro. In "Who has got the problem? Europe or Japan?" we argued that the bad Japanese trade data is just a symptom of the euro zone weakness and the current Japanese row with China, but no long-lasting issue.
We do not believe in the mainstream bushwah that argues that the yen is overvalued.
Recent trade history
A couple of months ago the euro traded close to EUR/USD 1.20 and the whole world was betting on its breakdown. We recommended to go long EUR in August on Seeking Alpha, based on the positive European current account data.
Once the euro downtrend ended thanks to QE3, OMT and the positive euro zone current account, the common currency did not stop to appreciate against the yen and reached levels of EUR/JPY 104 and above. Many short euro positions were short-covered and pushed the common currency even further up.
Our latest mid-term recommendation Short EUR/JPY at 102 on October 8 was lagging, but our shorts on metals and on Brent are strongly winning trades. We doubled our EUR/JPY Short at 104 this Tuesday. We wondered, how the yen could fall despite its negative correlation with commodities, especially with Brent?
Why are we short euro now and were long some months ago?
Fundamentally only little has changed. At EUR/USD of 1.22 or 1.23 the euro was undervalued and we went long EUR/USD. But now the common currency is now overvalued against the yen given that European consumers stopped spending.
Does the weak Japanese trade balance have an influence?
Not really a lot, for three reasons:
- The adjusted Japanese current account is typically 1 Trillion yen better than the trade balance. The current account might be positive again.
- The Net Exports component of the GDP of a rather closed economy like Japan does not have a big influence on GDP like for open economies like Switzerland or Sweden.
- Cheaper Brent oil will reduce the next Japanese trade deficit.
We strongly suggest that Japanese will continue to consume and that Europeans will keep their austerity path.
Japan will be able to reduce the trade deficit, but consumer spending will push the Japanese GDP upwards.
The following table shows once again how surprisingly irrelevant FX rates are for trade balances over the long-term (see details). Just after the Fukushima shock Japan started to see a trade deficit due to higher oil imports.
Is the yen overvalued?
The mainstream media continues their Keynesian talk:
"Prices have turned out weaker than the BOJ expected and the economy is slowing more than the bank anticipated, with both exports and domestic demand weakening," said Yoshimasa Maruyama, chief economist at Itochu Economic Research Institute in Tokyo.
"As such, I expect the BOJ will top up its asset-buying program by 10 trillion yen next week as it comes under pressure from the real economy as well as from politics."
For the better part of the past decade the world's third-largest economy has been caught up in the vicious circle of price declines that discourage investment and make consumers put off spending, which in turn weighs on demand and output. (source Reuters)
As opposed to the United States and China, Japan has seen deflation over the last two years. Even if the USD/JPY has fallen by 5%, from 84 to 80 since September 2010, deflation allowed Japanese companies to produce at lower costs (according to producer price index, PPI, or the Japanese CGPI):
- The US PPI was at 2.1% YoY in September 2012 and 6.9% in September 2011. Hence US products are 9.1% more expensive than in September 2010.
- Thanks to falling prime material prices, the Chinese PPI has fallen this year by -3.6%, but was up by 10% in September 2011. The Yuan however has appreciated against the dollar by 6.6% since September 2010. In total Chinese products are 13% more expensive than two years ago.
- Japanese CGPI is down this year by 1.4%, last year September it was up 2.6% on year basis. With the 5% increase of the yen Japanese goods are 6.2% more expensive in dollar terms than they were in September 2010.
Given that neither the ECB nor the Fed will hike interest rates soon, it is a clear case:
EUR/JPY and probably also USD/JPY will fall in the next months.
By: George Dorgan, Financial Consultant and Portfolio Manager,snbchf.com
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.