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Japanese Yen – Myths and realities

The Yen depreciated about 13% versus the US Dollar between 5^th January 2021 (a 9-month high) – and 4^th January 2022 (a 4-year low) but has since rebounded about 0.7%.

The Yen Nominal Effective Exchange Rate (NEER), which provides a more accurate overall picture of Japan’s currency and trade competitiveness and of the risks of imported inflation/deflation, has appreciated about 1%.

Yen weakness in past year has been partly due to deterioration in Japan’s goods trade deficit to a still modest 1.2% of GDP in September-November. The Yen-value of exports has risen rapidly in the past 18 months but imports have increased even more rapidly and from a higher base due to a modest rebound in consumer demand and increased import costs.

Going forward, we expect the trade deficit to stabilise, with new social distancing restrictions negating loose fiscal policy’s stimulative impact on consumption and imports. Domestic labour supply shortages – accentuated by self-isolation rules – and ongoing supply-side shortages are likely to dent Japan’s ability to fully capitalise on a competitive Yen and any material pick-up in imports, including from Europe, in our view.

The “safe-haven” Yen also weakened in the 12 months to early January due to capital outflows – the sale of low-yielding Japanese assets – driven by buoyant global risk appetite in our view. The Yen NEER has been strongly inversely correlated with the S&P 500 and has benefited from the near 10% collapse in the equity index since 4^th January. However, the common perception that the Yen has been used to fund long Emerging Market currency positions has not held true since mid-2020 with both tending to move in tandem.

The Yen NEER has historically only exhibited modest monthly seasonality, even in its weakest months (November and December) and strongest months (June and August).

Our core near-term scenario, premised on equities correcting lower, is of modest Yen NEER appreciation, its pace capped by our expectation that Japan will continue to run a trade deficit in coming months. Moreover, monthly seasonality has historically been negligible in the month of February.