On Friday, I outlined how Japan’s FX Catch-22 could end up weighing on US equities.
Make no mistake, it’s an important dynamic to understand. Generally speaking, risk moves opposite the yen and there’s also carry unwind when the JPY moves higher.
One hot topic in Japan recently has been Prime Minister Shinzo Abe’s plan to delay a sales tax hike that some commentators (notably Paul Krugman) fear may further derail the country’s nascent economic recovery. As I discussed last week, Abe used the G7 summit to telegraph the delay. I also asked the following question:
“...isn’t there the possibility of yet another lose-lose dynamic taking hold here for Abe? What happens, for instance, if the details surrounding the delay in the consumption tax end up boosting market confidence in the future of Japan’s economy and thus drive yen strength? That would obviously be a disastrous outcome as yen appreciation would negate the economic strength that triggered it in the first place!”
Well overnight that’s exactly what happened. Although there are a number of possible explanations for how traders interpreted the fiscal stimulus measure (because that’s what delaying a tax hike amounts to), they are all bullish for the yen. Or at least for today they are.
Abe announced the delay (until 2019) and the yen promptly rose more than 1% against the dollar and was stronger against all 16 of its major peers.
(Chart: Bloomberg)
"It’s getting harder and harder to push through the sales tax when the economy is pretty much back in recession -- I’m not surprised it happened," SocGen’s Kit Juckes told Bloomberg.
Note that there are several factors at play in the overnight yen strength.
First, it’s one of the most popular haven trades on the planet. As noted above, when investors are in risk-off mode, the yen is bid. Personally, I find that amusing. It reminds me of when people tell you to own gold because it’s essentially a hedge against the end of the world even though if the end of the world did come, gold would be completely useless. Kind of like how it makes no sense to call the currency of a small island nation laboring under a quadrillion yen (literally) debt pile and a dying economy “safe.” Anyway, it is what it is and we got some bad data last night. The Markit/Nikkei Final Japan Manufacturing PMI fell at its fastest pace in three years. Data on Q1 profits and capex weren’t so hot either. Here’s a rundown from Goldman:
“Jan-Mar 2016 MOF Corporate Statistics showed a 3.3% yoy decline in sales on an all-industry basis (excluding insurance/financials), an even larger decrease than Oct-Dec 2015 (-2.7%). On a seasonally adjusted qoq basis, sales slid 1.0% (Oct-Dec 2015: -1.8%) and have now printed negative, albeit marginally, for five quarters since Jan-Mar 2015.
“Capex (excluding software) on an all-industry basis grew again in yoy terms, rising 4.3% in Jan-Mar 2016 (Oct-Dec 2015: +8.9%), but clearly slowed.”
PMI data out of China came in steady but still seemed to suggest that the engine of global growth and trade is likely to remain stuck in neutral for the foreseeable future.
So yeah, the yen benefited from safe haven flows.
But obviously, the sales tax delay was the catalyst and there are several different ways to explain the ensuing yen rally. The first angle is that the market may think the postponement of the tax hike might help revive the economy. The second is that traders think it might make the BoJ think twice before easing again, especially after Abe referenced the “mobilization of fiscal policy.” The third angle - and this was the trader chatter - is that people were simply getting out of the way in terms of their USD positions ahead of Friday’s NFP report. Finally, there’s probably a profit taking element here as well.
However you slice it, the read through for risk, and thus for US equities, was just as I said on Friday: negative. Stocks started the session deeply in the red.
So as I said, please traders, do yourself a favor and mind the yen.
As far as the Bank of Japan is concerned, don’t expect them to be deterred. “I suspect they’ll ease anyway,” Standard Bank’s Steve Barrow told Bloomberg.
Indeed, Steve. Indeed.
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