Yesterday the Japanese Government decided to forcefully weaken the Yen by selling some of its own reserves. This follows the currency reaching a 15 year high against the US dollar on the 14th September 2010. The last time the Japanese intervened on their currency was in 2004 when the Yen traded at 109Y to the US dollar, significantly all they achieved was to slow, but not stop, the Yen’s long term trend.
Why has the Yen been strong?
There are several underlying reasons for the Yen’s strength although two main areas stand out. Firstly, the Yen is now viewed as a safe haven relative to the Euro and US Dollar, because Japanese debt is predominantly owned by government controlled agencies who are unlikely to default on their own debt. Whilst this cannot continue indefinitely, in the short term it does insulate Japan from global pressures. In addition the simultaneous fall of world interest rates in 2008/2009 ended the ‘carry trade’, where investors borrowed Yen, sold it for currencies such as the US dollar to benefit from higher interest rates. This weakened the Yen which benefitted Japanese exporters. With interest rates in the west at very low levels this ‘carry trade’ ended and since mid 2007 the Yen has risen over 30%. We believe that interest rates worldwide are likely to remain low and therefore the carry trade is unlikely to reoccur.
What does this mean for Japan?
For Japanese exporters the Yen’s strength means they receive less for their finished goods. This is not good for an economy with a high dependency on exports. Despite this, Japanese companies have managed to survive by implementing significant cost cutting, or by moving production overseas. As such any weakness in the Yen will allow Japanese companies to deliver significant profit growth.
What does it mean for investors?
In the UK a stronger Yen tends to be good news as the majority of fund managers do not hedge out currency movements. From 1st January 2010 to 14th September 2010 the Nikkei 225 has fallen 11.83%, but when these returns are converted into Sterling the index has risen by 3.39%. Of course any falls in the Yen would be detrimental to UK investors.
Our view
Over the long term we would expect the Yen to weaken. Domestic pressure from within Japan is significant, hence the government intervention. In the long term Japan’s ageing population and huge national debt will also contribute to a weaker currency. However, this is unlikely to occur whilst international investors look upon the region as a safe haven, given that the previous attempt in 2004 to weaken the currency failed.
Given this uncertainty we recommend investors stick to experienced fund managers who buy quality companies that are cheap such as GLG Japan Core Alpha, JO Hambro CM Japan and CF Morant Wright Japan.