Japan wins the forex ugly contest

IT IS testament to the uncertainty of the times that the yen, the currency of a country with public debt at over 200 per cent of GDP, is still viewed as a “safe haven.” But as CMC Markets’ Michael Hewson says: “Currencies are vying for the title in battle of the uglies” and the yen is a serious contender.

Ever since the euro crisis deepened five weeks ago, prompting a monthly euro low of ¥112 and a dollar low of ¥89, speculation has been rife that the Bank of Japan (BoJ) might move to stop the yen from strengthening further and hurting Japan’s vital export sector. These rumours were given a push recently when prime minister Hatoyama resigned (see chart), making way for his finance minister, Naoto Kan, who has said he would make efforts to “bring the exchange rate to appropriate levels”.

Most analysts, however, admit that direct intervention is unlikely, given its probable ineffectiveness and its potential to undermine efforts to persuade China to un-peg the yuan.

But while direct intervention is out, further QE and fiscal intervention are still possible if the dollar-yen drops into the mid-80s, depending on how the new prime minister chooses to address the public debt problem. Despite his more hawkish rhetoric, Kan is viewed with suspicion by the markets: his government has so far only promised to stabilise debt at 200 per cent of GDP.

Consequently, Capital Economics’ Julian Jessop sees the yen as almost certain to weaken
in one of two ways: either the government will fail to tackle the debt, prompting a fiscal
crisis and collapse in confidence in the yen as a safe haven, or “if the government does its
bit and tightens, the Bank of Japan (BoJ) would do its bit and loosen monetary policy”.
Jessop therefore forecasts a dollar-yen level of ¥100 by the end of the year.

A fall in the yen would help Japan’s electronics exporters, but this scenario relies on the
cooperation of external events: a global downturn or further euro crisis could spark
additional risk aversion that strengthens the yen no matter how the BoJ responds. Many are still inclined to view Japan as a viable safe haven: its high public debt is counterbalanced by low private debt and a solid financial sector. And there seems to have been a levelling out in consumer confidence.

But as Jessop points out, even if Japan does lead a recovery, there will still be pressure on the central bank to ensure a low yen, if not through direct intervention, then potentially by firing up the printing presses.

And growth is by no means certain. The country’s ageing population is quickly making its debt burden unsustainable as former high-saving earners become spenders in retirement. Saxo Bank’s John Hardy says that there isn’t anything the Bank of Japan can do:?“The situation will continue until there’s just a horrible collapse in trust in Japanese bonds and the currency.”

Even so, with the euro testing Brussels’ resolve and rumours of a second stimulus in time for mid-term elections in the US, the yen could still be the best of a bad bunch..