- Japanese currency falls to its lowest mark against the dollar since 1986
- Yen trades at all-time lows against gold
- Surge in Japanese bond yields to 13-year high and central bank intervention offer no support (at least so far)
- Tokyo’s travails could yet be a test case for the West
“Back in 2013, the Texas-based founder and manager of the Hayman Capital hedge fund, Kyle Bass, gave an interview in which he tersely stated, ‘I would buy gold in yen and go to sleep for ten years,’” says AJ Bell investment director Russ Mould. “It took some time for that view to play out, but play out it has, because gold is up 160% in yen since the start of 2023 (or, to put it another way, the yen has lost 62% of its value relative to the precious metal.
Source: LSEG Datastream
“The case for short yen/long gold was based upon tattered state of Japan’s public finances, the country’s weak demographics and how the Bank of Japan had got itself into trap whereby any attempt to tighten monetary policy would only lead to an economic slowdown and – in turn – lower interest rates and more money creation via Quantitative Easing.
“Japan’s currency has continued to tank, even as Japanese Government Bond (JGB) bond yields have started to rise. The yen has fallen to ¥161 to the dollar, a mark last seen in 1986.
Source: LSEG Datastream data
“That seems slightly counter-intuitive as normally higher yields would attract more capital. But JGB yields – and the Bank of Japan’s headline interest rate – are both much lower than their equivalents in the USA. Moreover, the Bank of Japan seems to be tightening policy more slowly than markets had expected and the Fed is moving more slowly to loosen than markets had initially hoped. As a result, the yield differential between yen and dollars is still huge, and the buck seems to be attracting capital at the yen’s expense.
Source: LSEG Datastream data
“The Bank of Japan’s glacial pace of tightening is offering little help to the yen, despite interventions in the foreign exchange markets to try support it. Under Governor Kazuo Ueda, the BoJ has managed one meagre interest rate increase and its balance sheet is still expanding, thanks to its ongoing Quantitative Easing programme. This is in stark contrast to the UK, EU and USA, where Quantitative Tightening is shrinking the monetary authorities’ balance sheets, to further tighten policy on top of the interest rate increased pushed through since 2021.
Source: FRED – St. Louis Federal Reserve database
“The Bank of Japan has at least – finally – achieved its objective of getting inflation back to the 2% mark after years of trying, but it may now be wondering whether it was worth getting that for which it was wishing. Inflation has run above that target for two years and a weak yen – a logical result of rampant QE and money creation – could make it hard to rein in price increases, especially as Japan now runs a trade deficit.
“That is largely the result of energy imports, as Japan has no major oil resources of which to speak and its energy supply policy is still recovering from the shock of the Fukushima nuclear plant accident all the way back in 2011. A weaker yen means more expensive imports and more expensive imports can mean more inflation.
Source: LSEG Datastream data
“This may leave the Bank of Japan and bond market vigilantes on a collision course, as holders of JGBs may not be too pleased to see inflation running well above the yields on offer from Japanese government debt.
“The good news here, at least, is that overseas ownership of JGBs has been minimal for years but this potential contest between the Bank of Japan and the currency (and maybe fixed income) markets is one that all Western central banks will be watching, especially as they are now looking to loosen policy once more.
“Mr Bass’ original bearish thesis on the yen was based on the state of Japan’s public finances, its weak demographics and the trap the Bank of Japan had got itself into. The West may face similar challenges, especially if government borrowing levels continue to surge and drag interest payments on those debts ever higher. On one hand, central banks may need to keep rates high to tackle inflation. On the other, they cannot afford a deep recession, as that would hit the tax take and drive government spending and borrowing higher still, so they may need to cut to avoid that, whether inflation is sticky or not.
Source: FRED – St. Louis Federal Reserve database
“Meanwhile, gold bugs continue to lurk. The Bank of Japan, and the yen, may be test cases for the view that central banks are in a corner of their own making after over a decade of experimental policy: either tighten to tackle inflation and indebted economies and leveraged financial markets turn turtle, or do nothing and see inflation do the damage instead.
“If nothing else, the yen’s collapse offers a salutory reminder of one invaluable investment lesson, as provided by Jesse Livermore, the legendary ‘Boy Plunger’ of the US equity markets in the early twentieth century. Despite his reputation as a brilliant reader of the ticker tape and a keen trader, Mr Livermore once noted, ‘The big money is made by the sitting and the waiting, not the thinking.’
“Mr Bass, for once, would surely agree.”
