April 13, 2016    4 minute read

Janet Yellen’s Yen

   April 13, 2016    4 minute read

Janet Yellen’s Yen

In stock indices, the global barometer is the S&P 500. In companies, the barometer is Alcoa, the light metals and manufacturing firm. As earnings season kicks off, all eyes will be on those two to give an indication of global aggregate demand and risk appetite going forward. It is expected that Q1’s earnings for most companies, given the stronger dollar relative to most currencies and the weaker oil price hurting the energy sector, will be substantially lower than previous quarters. As Janet Yellen repeatedly tells us, the oil price decline is transitory, meaning the FOMC ignores sharp rises or falls but assumes the price has settled. The problem is that if the price settles at a non-economic price level, earnings for the energy sector will continue to head down, along with their share prices. Keep an eye on the companies that generate most, if not all, of their earnings within the US. That should give a good indication as to the health of the US consumer and spending ability.

In currency markets, the barometer for risk-off sentiment is the Japanese yen. Even though the Japanese economy has had two decades of lackluster growth, the currency has always been stable; in many ways, it has gold like characteristics, in that it is a good store of value. When markets are booming, the yen will typically fall in value and capital will flow to the cyclical economies of the UK and the US, in turn appreciating the dollar and the pound. However, in recent times, even though the yen has been depreciating heavily versus nearly every other major currency, the state of the economy has not exactly been a blockbuster. That said, most of the weakness is due to the Bank of Japan’s large balance sheet and the US’ expected rate hikes.

Additionally, central banks globally are not buying as many dollars as they used to, hence a weaker dollar and a stronger yen. Moreover, Japan is running a current account surplus, which means the price of the yen is the rate at which Japanese investors are willing to sell their currency. On the flipside, the US has a current account deficit, which is the price at which foreigners are prepared to buy dollars. The Japanese are reluctant to sell yen at the moment, which keeps the currency inside Japan and not on the open market.

The fact that the Japanese yen has significantly strengthened in the last month does not entirely mean the world is going to collapse. Rather, a stronger yen could actually be a net positive for the economy, not a hindrance. It is true that a weaker currency encourages exports and a stronger yen, therefore, eats into the exporting firm’s profit margins. But many Japanese firms have used the retained earnings to invest overseas, where the conversion rate, when translated back into the local currency, is more favorable. Furthermore, because of the stronger yen, Japanese firms have not just stopped selling, so their market shares haven’t fallen. But from an economic perspective, a stronger currency allows cheaper access to pharmaceuticals, cheaper food imports, and lower oil, given it’s priced in weaker US dollars. Who benefits from this? The older population, which just so happens to be the age range which dominates Japan. If the government can continue to push through the structural reforms and get the economy growing at around 2-3%, it would not be surprising to see the USD/JPY go back to 60 yen per dollar. Of course, the main caveat would be the Bank of Japan having ended its QE policies.

If US earnings underwhelm expectations, expect the 100 barriers to be broken.

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