The yen was once used as a universal funding currency for global carry trades. That is, because interest rates were so low in Japan and higher almost everywhere else, Japan was a favored currency to borrow in to increase exposure in higher-yielding, risky assets. During the financial crisis, many of these global carry trades were unwound and the yen became a favored currency that appreciated during periods when risky assets such as stocks and commodities sold off. With expectations being adjusted for a depreciating yen, a pickup in global carry trades can add further fuel to the depreciation trends6.
A number of analysts initially reported 90 yen to the U.S. dollar as an ultimate target level for yen depreciation. That level has practically been reached, leaving some to wonder how much more the yen has to weaken. Nissan CEO Carlos Ghosn said that the yen was still too high, despite the weakness we’ve already seen. Ghosn considers “neutral territory” to be around 100 yen to the dollar.7
I believe much of the yen’s strength over the last five years was not caused by true fair value of the yen appreciating—much of it was sentiment driven. With sentiment having now changed dramatically, I would not be surprised to see the yen ultimately overshoot back above 100 yen to the U.S. dollar. There will be volatility in the near term, as the market trades on each statement from Japan’s policy makers about how close they are to accomplishing their mission to weaken the yen. But I believe it is clear the period of relentless yen appreciation we saw prior to Abe’s election is over.
WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ)
Jeremy Schwartz is director of research at WisdomTree Investments (NasdaqGM: WETF). This post was republished with permission from the WisdomTree blog.
1Source: Bloomberg. Specific period 11/13/2012 to 1/15/2013.
2Refers to the greater than two-thirds majority held in Japan’s Lower Diet by Abe’s Liberal Democratic Party and his power to appoint a new head of the BOJ as well as a few other officials on the monetary policy committee.
3Hilary Whiteman, “Shinzo Abe: The Answer to Ailing Japan’s Problems?” CNN.com, 12/26/2012.
4See Caroline Baum’s Bloomberg article “Paulson’s `Bazooka’ Turned Out to Be Pea Shooter,” August 27, 2008.
5Source: Bloomberg. Basis point: 1/100th of 1 percent. Measure’s the five-year break-even inflation rate implied from yields to maturity on inflation-adjusted Japanese government bonds and five-year nominal Japanese government bonds. Since both bonds are issued by the Japanese government, they have equivalent credit risk, and the only difference in yield-to-maturity value should relate to the fact that the nominal bond must compensate the investor for inflation. “Yield to maturity” refers to the return derived from the bond’s current price accounting for scheduled payments of interest and principal between the present and the bond’s maturity.
6When investors borrow in yen, it has an equivalent impact as though they were selling the yen, which depresses its value. If the yen depreciates, investors can pay back their loans with currencies that become worth more compared to the yen; conversely, if the yen appreciates, investors must pay back their loans with currencies that become worth less compared to the yen.
7Adam Westlake, “Nissan CEO Ghosn Calls on Abe to Continue Weakening Yen, Stabilize China Relations,” Japan Daily Press, January 4, 2013.