FXY - FXY: Possible Upside But Don't Underestimate Japanese Modesty

2023-09-14 04:00:03 ET

Summary

• The FXY is a way to go long on the yen relative to the USD.
• The yen has depreciated YTD due to Fed rate hikes and Japanese ultra-dovishness.
• New BoJ governor, Ueda, may end up being more hawkish, but the current speculation on the yen may have prompted the signaling, and not fundamentals.
• The BoJ will ultimately act on fundamentals, and modest spending in Japan despite the wage increases is a disinflationary sign, rather than a desired inflationary sign.

The Invesco CurrencyShares Japanese Yen Trust ETF ( FXY ) is a pretty reasonably costed way to go long on the Yen relative to the USD. The Yen has seen meaningful depreciation YTD on account of the Fed rate hikes in the face of Japanese ultra-dovishness. New BoJ governor, Ueda, was supposed to be more hawkish but ended up for the time being running with his predecessor's line. That may come to an end, but we are more inclined to believe Ueda's August statements compared to his more recent September statements, which come after further speculative pressure on the Yen may have prompted some more aggressive signaling to stave off the vultures. We'd stay away on a pure FX bet, instead opting for SME Japanese equities, for reasons we'll fully elaborate.

Discussion

So the timeline is something like this. Ueda takes control at the beginning of the year, quite quickly trouncing speculators going long on the Yen by keeping a dovish stance.

Why is Japan dovish while the entire rest of the world is not? Demographics and deflationary, underlying modesty in Japan have led to exceptionally low inflation, to the point of risking deflation, for decades since the 90s crash. Deflation is infinitely worse than inflation. It's a death sentence for an economy - completely unacceptable. While undesirable, even hyperinflation is better for the health of the consumer economy than deflation, because deflation spirals into people deferring consumption en masse.

Japan is also quite self-sufficient, so supply side issues weren't extreme in Japan, as compared to Europe for example, despite the fact that Japan is not geopolitically independent and had to shoot itself in the foot with some of its Russian arrangements including on Energy. Chip bans too have caused some unraveling with China.

Inflation hasn't been that high, especially core measures. Japan actually wants to capitalise on the inflationary push, even if it's mainly exogenous, to get inflation back to healthier levels, compared to risking deflation. The shunto wage negotiations went well. Wages went up more than 3%. Still this did not translate into more consumption! GDP spiked in Japan on net export increase, but consumption shifted to domestic sources and was down slightly overall despite higher wages.

This inflation situation globally from the Ukraine war and some COVID-19 overhang is an opportunity Japan won't squander. This is what we've been saying consistently for a year now. In August, Ueda signaled that inflation is still below target , expectations went out for rate hikes starting only in 2024. Then a couple of weeks later, the narrative suddenly changed saying that they may end negative rates soon .

This is a major surprise, but we think it is more of a ploy to get speculators off the Yen's back. Between August and September the Yen saw renewed pressure, and even FX intervention ideas were floated. This is basically the FX intervention idea, but more effective than just doing some one-off buys of JPY.

Bottom Line

The initial comments still stand. Inflation needs to rise to more sustainable levels in Japan before the end of ultra-accommodation. The wage increases have not translated into more spending. Japanese companies in our coverage are not guiding for higher consumption towards the end of the year either, expecting sequential flatline. The Japanese were modest with their wage increases. Demographics still is to blame. Low fertility rates and family creation are huge problems for general consumption, where scaling up to larger houses and raising kids boosts the economy meaningfully. We are not sure Japan can easily hit its target without the ultra-accommodation. While the JPY probably doesn't have far too much downside, as the Fed is nearing the end of their campaign, and the EUR doesn't have as much reserve draw even if their rates are still going up, but a long bet seems a little too hopeful. We'll expose ourselves to the Yen through Japanese equities instead.

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