A three-decade recession, an ageing population and low birth rates – these three factors, coupled with the failure of the Bank of Japan to bolster its economy with massive amounts of quantitative easing and interest rate cuts leave little doubt over the relative health of the Japanese economy. Paradoxically, the yen was left seemingly unscathed in the aftermath of the UK referendum, perhaps even emerging stronger than ever – soaring against both the pound and the greenback against the backdrop of tumultuous negative real interest rates. Naturally, a strong currency is often analogous to a healthy economy. And if so the question is – why do investors see the yen as a safe haven despite the clear signals of dying consumer confidence?
The real answer is that they don’t – the source of the strong yen can ironically be traced back to the scepticism regarding the Japanese economy’s strength before the referendum. This led to the yen being heavily shorted by investors as a funding currency to purchase European stocks. In turn, the move created a plethora of highly leveraged individuals leading up to the Brexit vote, under the assumption that the likely ‘Bremain’ vote would accelerate, or at least maintain, the stability of the European market.
The Vote Of No Confidence
The untimely, and unlikely, result of the Brexit vote meant that these investors had to unwind their leveraged positions by selling off their purchased stocks to refinance shorted yen, thereby increasing its demand and leading to the rise of the currency. This rise has nothing to do with investor confidence in the Japanese economy – rather it is an attempt to eliminate risk, a noise generated from the misjudged calls of speculative short-term traders. The ramifications of the stronger currency can already be seen in the fall of a tenth in share prices of Japanese car manufacturers, as well as a decrease of 8% in the Japanese stock market. Furthermore, JP Morgan predicts that Nissan and Honda stand to lose as much as 17% of operating profits, should the yen stay at current levels.
The purpose of the Bank of Japan’s decision to cut rates was to stimulate the economy through higher export potential. Not only did the central bank fail to do so due to lack of local investor faith, but the Brexit vote now acts to reverse the little effect the Bank of Japan has had, paving the path to further monetary easing in the coming years through the uncertain political climate. The shorting of the yen isn’t conflictual with the wishes of the Japanese government. In fact, by creating an excess of yen its face value should in theory decrease. What one cannot predict is in fact what happened after June 23rd, where the reverse occurred and buyback occurred. Global growth is already being threatened by the Brexit vote, and the Japanese market still has room to sell-off, ultimately creating an even stronger yen. The illusion of a rising yen doesn’t spell stability. Its rise only spells uncertainty – adding fuel to both the economic and political fire seen today.