Japan’s banks look insulated to current turmoil but yen’s strength could hurt overseas earnings of multinationals

Markets remain in a state of flux as concerns about the health of global banking system persist. These concerns are partly reflected by the surging asset inflows into US money market funds which have surpassed $5.1trn last week and are now notably above the previous peak of $4.8trn reached when Covid rocked the markets in 2020. Bank deposits at smaller US financial institutions have also continued to notably shrink suggesting a flight to safety which in turn have raised concerns about a much tighter credit stance by financial institutions which some suggest could be equivalent to as much as 150bps rate hike by the Federal Reserve.

Thus, the market seems to have come to the view that the latest banking turmoil will do much of the work in taming inflation and chances for easier monetary policy this year has dramatically increased. Indeed, the US central bank raised its benchmark rate by only 25bps last week, suggesting that although the US banking systems remains sound, “recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation”.

In our own market in Japan, we remain fairly glued to what is happening outside given that domestic interest rates have remained close to zero and there are no tangible signs of any stress on the country’s financial institutions. As we noted last week, although we might see some write-downs in Japanese banks’ holdings of overseas collateral loan obligations (CLOs), these lenders have been stress tested for their exposure to this asset class in the past two years and generally look fairly insulated from much of these negative external factors. 

What is more notable though is that the recent flight to safety has once strengthened the yen which had been weakening before the SVB bankruptcy, stemming from dimming hopes for any major monetary policy pivot by the BOJ in the near term. But with $¥ rate now testing the lows of 130 level, overseas earnings outlook for Japan’s multinationals will once again come into question as weak yen had greatly flattered their bottom line until Q4 of last year when the forex rate was high as 150 level. With overseas demand for goods remaining weak, we think Japan’s top exporters look far more vulnerable to negative earnings surprises than its financials.

As we also noted last week, with JGB yields having also dropped since the banking turmoil emerged, with the ten-year yield now around 20 bps below the central bank’s 0.5% ceiling, this development has provided the incoming BOJ governor, Ueda-san with a unique opportunity to further widen the Yield Curve Control band and resume BOJ’s bond lending operations to improve the functionality of Japan sovereign debt market. This is especially the case as Japan’s underlying inflation outlook remains fairly high relative to central bank’s more benign forecasts which have thus far proved far too optimistic. With the above scenario in mind, we retain our bullish view on the yen with our $¥ target of 120 or lower by summer remaining intact.