Yen’s recent snapback and its implications

The yen’s continued gains against the dollar from its late October lows has provided a surprise year-end twist to what had been an awful showing by the Japanese currency in 2022. The combination of MOF’s intervention in the currency market which helped drive away speculators in further shorting the Japanese unit and growing anticipation of a Fed pivot towards more moderate interest rate hikes going forward has helped the yen regain some of its lustre and possibly re-establishing its safe haven characteristics.

Another source for yen strength has been the growing anticipation of a BOJ pivot in exactly the opposition direction. This is evident by observing the recent moves in Euro/Yen rate which has also started falling, albeit at a more moderate pace. Indeed, as inflationary forces in Japan has continued to overshoot the central bank’s outlook and with Mr Kuroda’s term as BOJ’s governor coming to an end in April of next year, expectations are rising that BOJ’s yield curve control will be tweaked in allowing longer term rates to head higher, either just before the new governor is appointed or just after.

Come what may, the Japanese currency which on a price purchasing parity was already undervalued at the start of this year had become extremely oversold by October and it remains attractive still in the medium term. With the dollar/yen rate having recently broken down below its 200-day moving average, first time below that line since February last year, charts seem to be pointing to much more downside to come. This in turn is forcing Japan’s institutional investors to more aggressively hedge their dollar exposure against currency risks which is leading to more yen buying.

So, what had become a vicious circle for the yen this year, partly thanks to aggressive rate hikes by the Fed and BOJ’s ongoing policy errors of keeping its monetary policy too loose is now looking to become a virtuous one. However, a stronger yen will also remove a major support buffer for Japan’s corporate earnings, especially if weak overseas demand persists. This will leave shares of Japan’s multinationals particularly vulnerable as the dollar/yen rate has already fallen below what most have budget for in this quarter and should provide another headwind for next term’s earnings outlook.

This in turn is likely to provide investors with great shorting opportunities in names whose dollar earnings have been notably inflated by weaker yen this year and has masked the negative impact of falling demand volume in terms. As we underlined last week, the sectors which we continue to think will outperform and benefit the most from BOJ’s likely pivot are banks and insurance stocks. We should note that they are also fairly unaffected by yen’s appreciation trend.