Japan: The empire of the rising yen

Dubai - Tokyo's money market could well be the crucible for its stronger currency

I had published a column in Khaleej Times just last week predicting a 2,000-point fall in India's BSE-Sensex index but even I was surprised by its 510-point fall in a single session.
Despite higher US Treasury bond yields and imminent Federal Reserve monetary tightening, the Japanese yen has risen as much as a stellar 6 per cent against the US dollar in 2018 alone. Geopolitical risks, trade tensions, flows into the Japanese stock market, safe-haven bids on Wall Street sell offs, end of Japanese fiscal year repatriation flows and fears about a rollback of the Bank of Japan's epic asset purchasing programme have all contributed to spasms of yen strength. Deutsche Bank argues that, as in Europe in early 2017, global investors are taking a forex unhedged bet on Japanese assets and its currency strategists believe the yen will grind higher to 100 against the US dollar by end 2018.
The Tokyo money market could well be the crucible for the stronger yen. The Bank of Japan has begun to discreetly reduce its quantitative easing purchases of Japanese government bonds as it seeks to slow down its monthly QE purchases to ¥40 trillion at a time when Japan experiences its highest consumer growth rate since the end of Tokyo land share bubble in 1990. This trend, if it accelerates, means the Japanese yen moves higher even though Abenomics' "second arrow" once meant a lower yen to boost Japan Inc's global exports.
Secretary of State Rex Tillerson's humiliating sacking by Twitter, Gary Cohn's resignation and rumours about tensions between the [resident and National Security Advisor Lt-Gen H.R. McMaster reinforces investor disillusionment with the Trump White House. This means selling the US dollar even as the US economy reaches the limits of the Federal Reserve's growth and inflation mandate.
The rise in the yen and Swiss franc against the Canadian dollar, Aussie dollar, the Kiwi and the greenback tell me that trade tensions and the UK/Nato spat with Russia over the Salisbury spy poisoning case are leading to higher risk aversion in the global foreign exchange market. I believe the strength of the British pound on its crosses and the fall of euro/yen to 130 reinforces this conclusion, as does the fall in the 10-year US Treasury note yield to 2.83 per cent. This is entirely justified since President Xi Jinping's decision to anoint himself China's first autocrat - for life since Chairman Mao, Trump's selection of a ultra-hawkish CIA director as America's top diplomat to replace Tillerson, Vladimir Putin's military interventions in Crimea and Syria and the latest UK-Kremlin tensions mean Great Power conflict is now the defining feature of international relations. Political risk now haunts financial markets. This trend is bullish for the yen and the Swiss franc and bearish for emerging markets/commodities/currencies.
As I watch CNBC reminisce about JPMorgan's shotgun marriage with Bear Stearns, I cannot hold back my fear that excessively indebted banks and governments could teeter on the edge of default as US dollar interest rates continue to rise. For now, the disappointments in US housing starts and expectations that Jay Powell will not rock the boat at his first FOMC conclave means a "soft" US Dollar Index trending as low as 89. It has not surprised me to see the Canadian dollar plummet to lows at 1.31 as Planet Forex reprices policy risk in Ottawa. The Bank of Canada will simply not raise its policy rate amid such an unsettled international milieu, the reason the loonie has tanked in the past month. The FX option market premium skews tell me that the smart money expects the recent bearish trend for the loonie to continue.
I have been long sterling since 1.32 and see no reason to book profits even though it is possible that the City of London could be hurt by Putin's retaliation against Britain. Sterling is anchored by the prospect of a Bank of England base rate hike in May and November as Governor Carney simply cannot ignore the post referendum increase in UK food and petrol prices. Theresa May's decision to expel 23 Russian (Soviet?) "undeclared intelligence officers" (that is, spies!) boosts her stature in the Conservative Party as well as in Whitehall/Westminster. Germany and France's decision to back Britain against the Kremlin is also cable bullish, though I wonder if a reelected Chancellor Merkel will help the Brexit talks. To confirm upside momentum, I need to see sterling stage a decisive breakout above 1.40, which will happen next week.
The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.

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