The Yen is vulnerable. Yields on Japanese 2-year sovereign bonds are as low as -0.26%, inflation is persistently low (and seems likely to stay that way for a while) and GDP tilts from contraction to expansion and, in aggregate, barely grows. Currencies such as the US Dollar, the Pound Sterling, and even the Mexican Peso provide plenty of reasons to buy them over the Yen, and yet, the Japanese Yen holds sway. The reason? Global Stocks are underperforming.
Japanese corporations are basically cash machines, hoarding vast amounts of cash that they need to invest. The problem is that Japanese corporations’ default choice has always been buying the highly liquid Japanese sovereign bonds, despite their ridiculously low yields. If market sentiment is upbeat, if stocks perform well, and the global economy seems stable, Japanese corporations are willing to take the risk and store their cash in foreign assets, thus pushing the Yen lower.
But if stocks stagnate, Japanese investors quickly revert to buying Japanese debt, thus keeping the Yen high. In other words, when stocks return to bullish sentiment, Japanese corporations will start buying foreign assets and stop repatriating funds. But the question is what do stocks need to turn bullish again and allow the Yen to weaken?
Two Risks that Weigh on Stocks
The first risk is the Fed’s summer rate hike. Although this writer believes a September rate hike is more likely, at present investors are largely confident of July as the most probable month for a rate hike. Investors are worried about the repercussions of another rate hike on earnings.
The second risk that looms is Brexit. Though highly unlikely, an exit by the UK from the EU after the June 23rd referendum would probably radiate across all global stock markets and create quite a sell-off. Investors would rather wait for the risk to pass before taking additional risk in stocks.
Things Could Change in the Summer
But the two risks that loom on global stocks are set to fade in the summer. If the Fed does, indeed, hike rates it will be after economic data in the US validates, beyond any doubt, that the US economy is back on track. So far, judging from housing prices and consumer spending, it seems that the US economy is heading in that direction.
Even if a rate hike comes as early as July, if data from the US is solid, investors will be confident in buying stocks again.
With the chance for Brexit being rather remote, despite mixed polls, on June 24th, a day after the referendum, if Britons did indeed choose to remain in the EU (as they are likely to) the risk will fade in an instant.
With both risks temporary and set to fade over the summer, it’s likely that with it, appetite for stocks will return and with that, the return of Yen selling.
Look for my post next week.
INO.com Contributor - Forex
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.