Despite its reputation for formality, the Japanese language is evolving all the time. New words, often portmanteaus of existing terms with established traditional characters, are constantly being coined and added to the lexicon to keep up with the trends, fashion and matters of importance of the day. That Japan has such vocabulary for the relative strength of its currency – enyasu (円安) and endaka (円高) – for ‘weak yen’ and ‘strong yen’ respectively, says much about the perceived importance of this variable.

In recent weeks all the talk has been of enyasu, a sharply depreciated yen, and so to this topic we turn here. Below we attempt to diagnose why the currency has cheapened so much of late, what might perpetuate or arrest that decline and what the implications could be for Japanese companies and their investors. We hope you find it useful.

The value of the yen against the US dollar (or more accurately the price of the US dollar in yen) notably weakened in September and October of last year, and again in March 2022.1 In nominal terms, the yen is now cheaper versus the Dollar than it has been at any time since 2015. The root cause of this currency depreciation is inflation, expectations for it, and its implications. Differentials in expected (now realised) inflation between the US and other economies and Japan have driven a divergence in government bond yields. This expanded yield premium for US government debt has sucked capital away from Japan and led to selling of the yen.2
Yield curve control

This effect has been reinforced by the Bank of Japan’s policy of Yield Curve Control (YCC). Under YCC, the yield on ten-year Japanese government debt (JGBs) is capped at twenty-five basis points (0.25%) by a commitment of unlimited buying by the central bank. This facility had been little used since its introduction in 2016 but was relied upon more than once in late March this year.3

 

Meanwhile, higher oil and gas prices – already on the rise but supercharged by the Russian invasion of Ukraine – have deepened the yen’s slump. This dynamic jars with the commonly held presumption that the yen will always be a safe-haven currency, reliably appreciating during times of global turmoil. We covered the impact of higher oil prices upon a resource-poor Japan in an update last month.

 

It is important at this point to remind readers that we are neither professional macroeconomists nor currency strategists, so we will refrain from ‘calling the yen’. That said, those who choose to do so should concentrate their thinking around the yield differential mentioned above. This in turn will be determined by inflationary expectations for both the US (and other economies) and Japan, and whether yield curve control is maintained.

Will Japan’s deflationary bias persist?
In the case of US inflation and the likely path of US interest rates, there is certainly no shortage of opinion on that topic among market observers. Regarding Japan specifically, the views of economists vary widely. Many expect Japan’s deflationary biases – its ageing demographic, ingrained resistance to rising prices and timid labour unions – to keep a check on inflationary pressures. For example, Masa Adachi of UBS expects Japanese CPI to peak at 2% but then fall back to a more sustainable level of 1%.4 In such a scenario, Japan’s real yields would go negative but only moderately so. Until we see evidence to the contrary, this seems to us like a reasonable best guess.

Some commentators are much more aggressive, however. Last month the influential economist Yukio Noguchi of Hitotsubashi University said in a speech that “Import prices are already 40% higher year on year and, in a few months, this is likely to push up Japan’s CPI by roughly 4%”, before likening the yen’s fate to that of the Venezuelan bolivar if the Bank of Japan does not change tack on YCC.5 If Noguchi’s scenario plays out he could be right, but that is a big if.

The more inflationary one’s expectations are, the more important it is to form a view on the Bank of Japan’s commitment to suppressing government bond yields. If the BoJ reneges on this commitment, yields can rise and the flow of capital away from Japan could be stemmed, likely strengthening the currency.
Politics is key
Which way the BoJ goes from here could be determined much more by politics than economics; the reason being that enyasu is broadly positive for big business – more of that next – but bad for consumers and smaller companies with only domestic sales. The current tension pits pro (big) business Governor Kuroda and the Bank of Japan against Prime Minister Kishida and his redistributive agenda.6 Who will win?

Comments by the Chief Cabinet Secretary Hirokazu Matsuno; “We will monitor the trends in foreign exchange markets…It is up to the BOJ to decide specific approaches to monetary policy, but we expect that (the BOJ) will cooperate with the government to take necessary steps.” hint at the pressure the central bankers will be under to step away from YCC.7 Should the politicians win over the bureaucrats, the current period of yen weakness could end abruptly. We believe it is worth keeping an eye on this tussle.

Let’s step aside from why the yen has depreciated, or where it could go from here to think about how it might affect the kinds of Japanese companies in which we invest for our clients. The old rule of thumb is that a weaker yen is good for the export-heavy Japanese market, but does this still hold? According to the economists and strategists for whom such number crunching is their stock in trade, the answer appears to be ‘yes’, but not as much as it used to.

Mizuho Securities estimate that a ten percent depreciation of the yen against the US dollar should elevate Topix earnings per share by six to seven percent.8 Analyses by Daiwa Securities conclude that a ¥1 cheapening against the US dollar should lift pre-tax profits by 0.4% in 2022 but would have generated a 1% uplift in 2009.9 The difference here is partly because a ¥1 move in a stronger 2009 yen would have been a more meaningful percentage deviation than it would be today, but it is mainly to do with Japanese manufacturers’ decades long project of localisation. Back then, endaka rather than enyasu was the preoccupation.

As an aside, domestic bulls will hope that the weaker yen could stimulate reshoring of production. Given that the real effective exchange rate for the yen – which uses a basket of currencies and is adjusted for inflation – shows the currency to be at its cheapest for half a century10 , they may have a point. For the same reason, Japanese hotels, restaurants and souvenirs will feel remarkably cheap to overseas tourists when they are finally allowed to return to the country, probably later this year. Domestic consumers, squeezed by higher input costs, will not be feeling quite so chipper.

Meanwhile, a weaker yen is clearly a headwind for companies reliant upon largely domestic sales but with significant import costs. Bank of America highlights some chemical and pharmaceutical makers as being particularly exposed, but restaurants and retailers could be the centre of the bullseye.11
Weaker yen = higher profits for Japan Inc?
To summarise, the current weakness of the Japanese yen is a function of inflation and its implications for interest rates overseas and rising commodity prices. Those bold enough to form their own expectations for foreign exchange markets will need to consider whether future differentials in inflation and interest rates are being assessed appropriately by the market – quite a task. A further complicating factor is the Bank of Japan’s commitment to suppressing government bond yields, if this is to slip under pressure from the government then we could shift from enyasu to endaka very quickly.

For those not disposed to making such calls – ourselves included – the current reality of a weaker yen does still mean that aggregate Japanese profits are likely to be boosted, though the effect has been dampened over the years. The winners may be almost matched by the losers – importers with largely domestic sales. Some of these losers will be best avoided, but with some share prices having already been trashed it may be that stocks as well as the yen prove to be remarkably cheap.
1 Bloomberg, April 2022
2 Yen slide breeds uncertainty over BOJ yield cap policy – Nikkei Asia
3 UBS, Who can stem the Yen’s fall? Adachi, March 2022
4 UBS, Who can stem the Yen’s fall? Adachi, March 2022
5 Mizuho, Japanese investor trends in rapid yen depreciation period, Kikuchi, March 2022
6 Kishida eyes fresh spending package to cushion blow of rising costs | The Japan Times
7 Yen’s weakness casts a pall over Japan’s economy | The Japan Times
8 Mizuho, Kikuchi, April 2022
9 Weak yen loses its magic for Japan’s manufacturers – Nikkei Asia
10 UBS, Who can stem the Yen’s fall? March 2022
11 Bank of America, USDJPY hits 7-year high – Qui Bono? March 2022

The value of active minds: independent thinking

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