Japan’s Safe Haven Appeal

February 24, 2011

The yen’s advantage in times of geopolitical turmoil and rising oil prices is not intuitively obvious.  Japan imports virtually all of its energy needs, and Middle Eastern hydrocarbon fuel comprises a big share of that purchase.  Japanese economic activity is looking better but only in relation to late 2010 when such stumbled rather badly.  Prime Minister Kan’s cabinet has a sub-20% voter approval rating, as his Democratic Party recently was tainted by corruption allegations involving one of its founders and leading members.  Public finances are going from bad to worse, with gross debt set to surpass 200% of GDP soon.  As in the United States, political opposition is holding day-to-day government operations hostage.  In Japan, the demand is for new elections, or the budget may not get approved.  Earlier this year, S&P downgraded Japan’s debt rating to AA- from AA, concluding that the debt ratio may crest higher than had been assumed previously.  Mild deflation persists in Japan where non-seasonal food core consumer prices fell 0.4% in the year between December 2009 and December 2010, while the non-food, non-energy index dropped by 0.7%.

Japan for decades has been a natural exporter of capital.  The country runs a chronic current account surplus, which widened 28.5% last year to JPY 17.08 trillion, equal to 3.6% of nominal GDP.  In addition, Japan has habitually low interest rates.  The Bank of Japan’s overnight target call money rate target has not been above 0.5% since the beginning of September 1995.  The yield on ten-year government bonds has averaged 1.25% this year and 1.44% since the start of 1998.  In times when there is any semblance of normalcy in the world and unless a substantial rise of the yen appears imminent, a powerful incentive exists to park wealth in higher-yielding overseas assets.  But when risk is shunned, the yen tends to appreciate.

Investors do not have to worry unduly about an upward spike in the yen now.  Japan’s currency for some time has been not far from its record dollar high of 79.85 and therefore under threat of intervention to prevent additional cumulating appreciation, and this has helped foster the currency’s stability.  Against the dollar, it has traded this year between 83.98 and 81.13, thus wholly incased in the 89.15 to 80.25 per dollar range of the second half of 2010. 

The yen has benefited from general flight to safety in the past.  During the most frightening segment of the Great Recession, the yen advanced 39% from 170 per euro on July 23, 2008 to 122.4 on March 6, 2009 and by 14.6% from 110.66 per dollar on August 15, 2008 to 96.58 on 03/06/10.  Even as the recession’s severity lessened but uncertainty stayed high, Japan’s currency continued to climb to peaks of 105.44 per euro last August and 80.25 per dollar last November.

A run-down of released Japanese data during the past month provided the following highlights.  Conditions were mostly better but not thrilling.

  • Core machinery orders, a leading indicator of business spending, recovered 1.7% in December but fell by 6.9% in 4Q.  Survey evidence is pointing to an increase in core domestic orders of between 2.5% and and 3% in the first quarter of 2011.  Foreign machinery orders sank 7.7% in December but are forecast to climb about 28% in the present quarter.
  • Industrial production posted consecutive gains of 1.0% in November and 3.3% in December. 
  • Retail sales fell by 2.0% in December and 0.4% in 4Q10.
  • Real GDP fell 1.1% at a seasonally adjusted annualized rate last quarter, trimming calendar 2010 growth to 3.9%.  Net exports, personal consumption and inventories accounted for 90% of last year’s growth in GDP.  The GDP price deflator dropped 1.6% between 4Q09 and 4Q10.
  • The all-industry index, a supply-side approximation of GDP calculated monthly, declined each month of the fourth quarter.
  • Housing starts and construction orders were both higher than a year earlier in December.
  • The 44.3 reading in the economy watcher’s index in January exceeded the fourth-quarter mean score of 43.0.
  • Likewise, consumer confidence rose to 41.1 in January from 40.1 in December and an average 4Q reading of 40.5.
  • Small business sentiment (45.8 in November and January flanking a score of 45.9 in December) remains fragile, printing below the 50 demarcation line between optimism and pessimism.
  • January’s purchasing managers index in January of 51.4 was 3.1 points above December’s reading and at a six month high.  The services PMI edged up marginally, and the composite score swung from a sub-50 49.4 reading in December to 50.9 last month.
  • Expressed as a diffusion index, the leading economic indicator surpassed the break-even 50 level in January for the first time since last May.

Both the Bank of Japan and the government upgraded their economic assessments and for the same reason, namely better trends in exports and industrial production that are related to strengthening foreign growth.  All that might be put in jeopardy in a worst-case scenario for Mid-East peace and oil production.  The volume trend in customs exports is not terribly inspiring, either, with on-year growth of 2.3% in January compared to 8.6% in the fourth quarter of 2010 and 24.2% for all of 2010.

Foreign exchange trading oftentimes resembles the Bizzaro world of the comics.  A spike in world oil prices benefits the yen even though Japan is vulnerable to supply disruptions or more expensive imported energy.  It’s not that investors around the world suddenly send wealth to Japan.  In fact, the knee-jerk reaction is generally for everyone to keep funds nearby, and that’s true for Japanese investors as well of which there are many.  So higher returns abroad are forsaken for the security of less risk in keeping wealth at home in Japan.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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