Just what’s the matter with the yen?
As Tim Lee pointed out in yesterday’s FT, everything about the currency markets at the moment looks out of whack, to put it bluntly.
“A simple purchasing power parity exercise suggests that the New Zealand dollar is 20% to 25% overvalued against the US dollar, while the Turkish lira is about 65% overvalued. The yen meanwhile is roughly 30% undervalued.”
That’s not to mention the fact that the Japanese economy has experienced continuous growth for the past five years. And even though deflation has proved a persistent enemy, data yesterday found that Japanese corporate service prices rose at the fastest pace in more than nine years in May, rising 1.4% on the previous year – more on that later.
Yet the Japanese currency is at record lows against almost anything you care to mention. So what’s going on and how long will it last?
Tim Lee, founder of financial consultancy Pi Economics, points out in the FT that the main thing driving currency markets at the moment is interest rates, rather than any consideration of the economic fundamentals (or ‘fair value’ of each currency).
So you have traders borrowing in low interest rate currencies like the yen to invest in countries with high rates – the carry trade, as it’s called. Lee says this is a key symptom of the “global credit bubble” we’re now in. He puts the size of the trade at “at least $1,500bn”.
He argues that this has spilled over into “credit, equities and real estate markets”. But the trade can’t carry on for ever. “Ultimately there must be a sharp convergence of exchange rates with fair values, inflicting heavy losses on carry trades.”
What could drive this return to fair value? Lee doesn’t go into that in detail, but an obvious candidate is Japanese inflation. As mentioned in the introduction, corporate services costs are rising fast in the country. Mayumi Otsuma and Harumi Ichikura report on Bloomberg: “Faster growth in the costs companies pay for services such as transportation and rent may prompt them to raise prices, sparking inflation.”
Meanwhile, Japanese central bankers have been starting to talk up the yen. David Fuller of Fullermoney reckons “we can expect the BoJ’s next interest rate hike in August or September… the long-delayed but inevitable process of normalising rates in Japan will commence.”
Mr Fuller reckons that higher rates could actually be good for Japanese stocks, confirming “beyond any lingering doubt that Japan Inc really is back in business.”
Eventually, whether it’s down to rising rates or some other cause, the yen will strengthen. And that’s when we’ll find out just how much of an impact the carry trade has had on the global economy.
We can’t be sure exactly what will happen, as it’s impossible to tell where carry trade money has actually ended up. But if traders are forced to evacuate positions and the yen appreciates rapidly, we can certainly expect some serious turmoil throughout the markets. As far as we’re concerned, one of the best places to be invested (apart from in cash and gold, of course) at that point would be Japan – as a UK investor, you’d benefit from the surging yen, even if equity prices did fall in tandem with other global markets.
There are plenty of other reasons to be upbeat on Japan. In fact, MoneyWeek regular James Ferguson was out there just a couple of weeks ago and tells me that the investment story on the country’s property market is even better than he’d thought – and as regular readers will know, James is pretty bullish when it comes to Japanese property. He wrote up his detailed views for readers of his investment service Model Investor last week – you can find out more about the service here: Model Investor (http://www.fsponline-recommends.co.uk/mdiadv1?XMDIC301).
Source-Money Morning