How the Yen’s Rise Could Affect the Stock Market
The puzzling strength of Japan’s currency threatens the country’s exporters and sends U.S. Treasuries climbing.
Shocked! Shocked! Like Captain Renault discovering gambling going on at Rick’s in Casablanca, the revelation that some of the richest folks from around the globe found ways to avoid and evade the tax man with the help of a secretive law firm in Panama should be anything but a surprise.
The only shockers were some of the names in the millions of pages of data leaked from the firm of Mossack Fonseca, in what has been dubbed the Panama Papers. Among them were the now-former prime minister of Iceland, Sigmundur David Gunnlaugsson; the father of British Prime Minister David Cameron; Argentina President Mauricio Macri; and three of the seven members of China’s politburo standing committee, including relatives of President Xi Jinping, among others. Associates of Russian President Vladimir Putin also were mentioned, but he vehemently denied any involvement, calling the story another U.S. attempt to undermine him and Russia.
Elsewhere, big money was also under attack in Washington, as new tax rules aimed at curbing so-called inversions effectively scuttled Pfizer ’s (ticker: PFE) proposed $150 billion merger with Dublin-domiciled Allergan (AGN). Meanwhile, the Justice Department sued to block the $35 billion combination of oil-services giants Halliburton (HAL) and Baker Hughes (BHI). Indeed, since 2009, U.S. companies have dropped merger deals worth $370 billion, according to a Financial Times estimate reported last week.
CEOs also got involved in this highly politicized atmosphere. On the campaign trail, Vermont Sen. Bernie Sanders charged in a New York Daily News interview that General Electric (GE) is “destroying the moral fabric” of America, to which Jeffrey Immelt, GE’s chief executive, took umbrage. “We create wealth and jobs, instead of just calling for them in speeches,” he retorted in a Washington Post op-ed piece.
Hard to believe we’re only about halfway through the primaries, with months to go before the conventions, let alone November’s balloting. Still, it’s difficult to discern what impact the political season is having on the financial markets.
The presidential campaign is topic No. 1, not only in the U.S. but around the globe. Loomis Sayles’ veteran vice chairman, Dan Fuss, noted last week that on a recent trip to Japan, almost every meeting began with a conversation about the White House race, with a certain unnamed candidate (as if one couldn’t guess) dominating the observations.
Despite all the talk, the effect on the markets from the campaign has been hard to gauge, if indeed there has been any. Perhaps there are too many other factors to deal with that are producing persistent, discomfiting day-to-day lurches up and down.
That was apparent last week, especially on Thursday, when stock markets tumbled by 1%-plus, with bank shares—especially European ones—hit hard. At the same time, investors took refuge in their regular redoubts: U.S. Treasury bonds and the Japanese yen.
The rush into U.S. Treasuries was understandable. The highest-quality, most-liquid securities on the planet are also among the highest yielding. That anomaly reflects the descent of yields on many other governments’ securities into the investment Hades otherwise known as negative interest rates. The 1.72% offered by a 10-year U.S. Treasury looks absolutely lush, compared with the 0.1% provided by the comparable German Bund and especially the minus 0.08% on the 10-year Japanese government bond.
That should mean that money is coming to America, as in the Eddie Murphy movie of some years ago. But the dollar has been headed lower, while the yen in particular has been shooting into orbit. The yen’s ascent has been the subject of curiosity and confusion in the markets for a couple of months. After weakening initially to 121 to the dollar after the Bank of Japan pushed some interest rates below zero in late January, the currency has steadily appreciated. Initially, it firmed to the 112 to 114 range (meaning it took fewer yen to buy a dollar) in February and most of March.
But over the past week or so, the yen has surged to 108 to the dollar, hugely disconcerting the Japanese stock markets. According to the most recent Tankan survey of business, Japanese corporations are budgeting an exchange rate of 117.5; a significantly stronger yen would make their wares much less competitive. A warning from Japan’s finance minister, implying intervention, halted the currency’s advance on Friday, if only for the moment.
Yet rarely has a move provoked more sheer head-scratching as the yen leaped higher, which also has come against the euro, which in turn has risen versus the greenback. (Currencies are always traded in pairs, demonstrating the principle aptly articulated years ago by that great monetary theorist, Henny Youngman. In response to the query, “How’s your wife?” he replied, “Compared to what?”)
Currency-market mavens suspect that the counterintuitive rise in the yen and the euro in the past few weeks might be a result of some secret deal to stabilize exchange rates following the steep 25% rise in the U.S. Dollar Index from mid-2014 to its recent peak in early 2016. Since then, the index is off about 6%—even though the Fed made its first rate hike in December and the rest of the world’s central banks are easing monetary policy.
The fall in the greenback and rise in the yen probably reflect speculative flows, says John Vail, chief global strategist at Nikko Asset Management. But it also could indicate a “detente in the currency wars,” he added in a phone conversation on Friday.
Similarly, John Brady, managing director at Chicago futures broker R.J. O’Brien, suggests that global monetary authorities at the Feb. 26 Group of 20 meeting in Shanghai agreed to “cease and desist from additional beggar-thy-neighbor, currency-devaluation monetary policies.”
The European Central Bank adopted additional easing measures last month, including pushing rates further into negative territory. But, Brady observes, it also pledged to support corporate credits on bank balance sheets, such as troubled commodity companies Petrobras (PBR) and Glencore (GLEN.UK). That would mean no further rate cuts to depreciate the euro.
Similarly, Brady continues, the BOJ isn’t expected to further reduce rates or take other easing measures at its policy meeting on April 27 and is likely to eschew further currency depreciation to spur the Japanese economy. That would be in accord with the “whispered” agreement at the Feb. 26 G-20 meeting.
But here’s the rub: China’s currency, the yuan or renminbi. What the world (and U.S. politicians) watch is its exchange rate against the dollar. The yuan has strengthened, from 6.60 to the greenback in January to 6.47 on Friday, but still is weaker than when it was devalued from 6.20 last August. As the yen has gained on the buck, it has risen some 16.5% against the yuan, a bitter pill for Japanese exporters to swallow, he adds. That helps explain why Japan’s Topix is down 16.8% in dollar terms over that span.
WHILE FOREIGN EXCHANGE is the world’s biggest market, with some $5 trillion changing hands daily, it’s not what most readers of this space are most concerned about. Moves in currencies have implications for other asset classes, including stocks.
The yen’s rise also could be the “canary in a coal mine for global risk assets,” according to BCA Daily Insights. Japan’s currency and stock markets tend to be leading indicators for the U.S. equity market, having peaked ahead of the major tops in the Standard & Poor’s 500 index in 2000 and 2007.
There could be two reasons for this, BCA continues. The yen is a “funding currency”; that is, it’s borrowed to finance investments in other, higher-yielding assets in good times. When the tide turns and those positions are unwound, the yen borrowings are repaid, boosting demand for the currency.
In addition, JPMorgan economist Nikolaos Panigirtzoglou writes, reversal of yen currency hedges—a popular strategy that has been used in U.S. exchange-traded funds—by overseas buyers of Japanese stocks could have been huge this year: some $288 billion. BCA adds, “Because of demographic head winds, the Japanese economy is driven by the global business, as opposed to organic domestic demand. Weakness in Japanese stocks could herald slower global growth.”
Weak global growth was cited as a drag for the U.S. economy by Fed Chair Janet Yellen on Thursday evening, in a unique discussion with her three predecessors, Ben Bernanke, Alan Greenspan, and Paul Volcker. That has provided justification for the Fed to hold off from further rate hikes, even with full employment and 2% inflation, its domestic mandates having largely been met.
Three-quarters of the economists surveyed by The Wall Street Journal last week thought the Fed would raise interest rates again in June (only one out of 69 thought a hike was coming at the April 26-27 meeting). Presumably, their forecasts are based on the U.S. economy having met the Fed’s criteria. But the federal-funds futures market on Friday put the chances of a hike at just 16% by June and a shade under 50% by December, according to Bloomberg calculations.
If the futures market is right—and it has been more on target than economists and the Fed—its forecast would jibe with the central bank’s increased sensitivity to global economic and financial conditions. And staving off Fed rate hikes, while the ECB and BOJ cut rates, would support a pact to stabilize rate hikes, if such a scheme exists.
All circumstantial evidence, of course. But these money maneuvers seem to be having more impact than politics, for now.