- U.K. unemployment rose at the fastest pace since at least 1971 in February. (Bloomberg)
“Facts do not cease to exist because they are ignored.”
FX Trading – Is the yen the canary in the coal mine for a currency analysis?
Growing economic risk in Japan, reflected in the plunge in the Nikkei 225 stock index, seems to be finally hurting instead of helping the Japanese yen. So on our market tone scale, i.e. price action relative to the news, we would say the yen is acting normally for a change.
Starting in late 2004, the correlation between the Japanese yen and Japan’s stock market has been relatively tight. A falling stock market meant increased economic risks and increased economic risk meant repatriation back into Japan by major players. It seems Japan has had many of its internal risk aversion vs. risk appetite flows. And maybe this is what happens when you have a massive reserve base driven by a massive and ongoing trade surplus with the West. But, that game is changing fast.
As you know, Japan’s trade surplus has morphed into deficit. It seemed to stun those who actually still held out hope the fabrication referred to as “decoupling” might still hold some validity (but not those who know the export models will get crushed in a world when Mr. Consumer morphs into Mr. Saver). If trade deficits continue to stack up in Japan, as we surmise they shall, Japan’s massive exchange reserve base will shrink, as it will for all Asian export dependent players (and Germany in the West).
This we think is important because it should mean we will witness fewer mini-bouts of risk aversion and risk appetite going forward inside Japan. In other words, those institutions so flush with cash from said trade surpluses will no longer have it available to stretch for yield in overseas markets (nor will there be yield to stretch for as central banks everywhere normalize in their race to ZIRP (affectionately known as Zero Interest Rate Policy) which the Bank of Japan recently popularized during the “lost decade.”
Why is this important? Well, here goes. With the normalization of interest rates globally, capital should flow to those areas that exhibit the best intermediate- to long-term growth opportunities instead of being driven primarily by the creature that was popularized in the past cycle – carry: borrowing low in one place, to drive an asset bubble in another.
In the new world we see, foreign direct investment will gain sway over hot money capital flows as foreign direct investment by its nature reflects international confidence in the growth prospects for the economy.
And because we see many years of lower than once expected growth for those countries that relied so heavily on exports as opposed to consumer demand (the great rebalancing as we described in a recent CC), and the possibility of wrenching social tension during a transition to a more consumer oriented economy, thus we expect the currencies of those countries to underperform over the “foreseeable” future (assuming such a thing exists.)
And our favorite of the majors in line for a major haircut is the Japanese yen.