Further plunge in Japan currency could turn negative for stocks
In the past few weeks, we have tried to address the implications of the yen currency crisis currently unfolding, and potential dangers of it manifesting into a contagion in Asia and possibly engulfing all EM currencies. We have also explained why we think BOJ’s monetary policy is far from being data dependent and is seemingly heavily influenced by MOF which wants to keep government’s refinancing costs under control.
With inflation gauges continuing to tick higher at way above BOJ’s outdated low forecasts, there is a growing sense that the central bank will have to raise its inflation outlook to retain some credibility but will likely maintain its monetary policy course in the July 15-16 meeting. However, we think in this scenario of inaction, the yen is most likely to test its October of last year’s lows as currency traders pile in to add to their yen carry trade positions.
As we have also explained without tighter monetary policy, we think MOF’s likely currency interventions are unlikely to have a lasting impact and its repeated efforts would eventually be seen as yen selling opportunities. So, we see potentially a big storm this month as market forces look likely test the authorities’ resolve in trying to stabilise the dollar/yen rate below 150.
It is difficult to know for how long Japan’s stock market will tolerate the falling value of the yen which against other majors like the Swiss Franc and the Euro is hitting multi-year lows. Although a weak yen is generally considered positive for multinationals, typically Nikkei index names, we think there might come a point that overseas investors begin to get more concerned about their yen-denominated assets. This is particularly concerning for those equity investors who might not have adequately hedged against currency risk.
We also think that the JGB market has been looking somewhat complacent given Japan’s inflationary backdrop and the recent plunge in its currency. We suspect short sellers will come back again once macro funds start sensing that devaluation of the yen could eventually force a monetary policy change. Come what may, July promises to be an eventful month for Japan.