Insight

Safe-Haven Status

Along with the US Dollar and the Swiss Franc, the yen holds a safe-haven status, meaning that these currencies tend to retain or increase in value during times of uncertainty and market instability. The Yen as a safe haven is driven by factors such as Japan’s strong current account surplus (it exports more goods and services than it imports), positioning the country as the world’s largest creditor nation.

While Japan has held this title for the past 25 years, the country’s debt-to-GDP ratio surpasses all other nations by a wide margin at approximately 249.34%. This begs the question, how can the world’s most indebted nation, also be the world’s largest creditor nation? This dichotomy stems from the fact that Japan’s massive debt is held almost entirely by the Japanese public. In addition to leading the pack in terms of debt-to-GDP ratios, Japan has also been a leader in terms of low interest rates. For nearly 20 years, Japan has maintained near 0% percent interest rates as a means to stave off deflation and spur economic growth. These low-interest rates encourage investors to borrow Yen in order to invest that yen in higher-yielding assets from other countries. This is known as the carry trade, and in times of uncertainty, investors may unwind these trades which results in additional demand for yen.

On paper, the Japanese economy has a number of challenges. The country is constantly flirting with recession, doing everything it can to battle deflation, and working with interest rates so low that nearly 2/3s of the country’s debt trades at negative yields. With all these negatives, why would an investor want to own any yen? While the answer is multifaceted, it boils down to the fact that yen strength is simply not a function of domestic economic performance. During the financial crisis and its aftermath, the yen appreciated by more than 20%. Later, in 2010, worries about peripheral European debt led to a 10 percent appreciation against the euro. Ultimately, yen responds more to whatever is happening around it, rather than developments in Japan. One should certainly monitor the Bank of Japan, understand Japanese politics, and grasp overall fiscal policy, however, these factors only paint half the picture. In analysis and forecasts on yen, it is important to focus on the geopolitical landscape in East Asia and pay attention to economic and political developments from the other G10 nations.

2019 Outlook

The Japanese yen was the best performer of 2018, rising by 2.4% solely based on its safe-haven currency status as end-of-year panic aided it tremendously. This is remarkable as the US Dollar gained only 3.4% throughout 2018 and that was due to a hawkish Federal Reserve that raised interest rate a whopping 4 times. In contrast, the Bank of Japan remained static with its interest rate decisions throughout 2018 which is right in line with its policy of 20 years now. Additionally, the Japanese economy has continued to stagnate with a GDP growth average level of only 0.2% per quarter which hasn’t changed since 2009. This is completely in line with the overall trend of Japanese monetary policy which by nature makes the yen an inconsistent currency. Since yen strength relies on global market uncertainty, there are no certain economic factors that could see the yen lose or gain. Uncertainty is by its very nature, uncertain, which is hard to forecast. That said, there are a few international developments that may affect the yen in the long-run:

In addition to global economic forces, there are some domestic socio-cultural forces that may cause problems for Japan in the near future. As a whole, the population of Japan is one of the oldest in the world. The island nation has one of the highest life-spans for men and women, and this coupled with the low birth rate has caused concern since less and less working-age adults can keep up with covering for the welfare of their retired and aging population. This results in a downward spiral where fewer people for the workforce means employers have more trouble in finding talent which leads to less overall consumption. Many European nations have a similar issue but their aging populations are mitigated by the relatively young immigrant communities and continued immigration into these countries. Unlike countries in the West, Japan is a relatively homogenous society with an extremely low immigration rate. This lack of access to immigrant labor will definitely hurt Japan in the long-run, and this issue may be one of the few cultural phenomena that could translate into negative economic consequences for the yen and the country as a whole.

Something to keep on the radar throughout 2019 is the newly initiated EU-Japan Economic Partnership Agreement. It entered into force on February 1, 2019, and the agreement aims to do the following:

• Remove trade barriers faced by European firms exporting to Japan
• Help the EU and Japan shape global trade rules in line with their high standards and shared values
• Send a powerful signal that two of the world’s biggest economies reject protectionism

Seemingly a direct response to the Trump administration’s protectionist stance, the agreement will eliminate virtually all tariffs (close to 99%) between the two partners, expand markets for services and public procurement, and bolster regulatory cooperation. While this is a great boon for Japan, trade talks between the US and China might negatively affect Japan in the long-run. In January 2019, Japanese exports fell with a notable fall in shipments to China.  Total shipments declined 8.4% by value from a year earlier and registered a second consecutive monthly drop for the first time in nearly three years. More specifically, the outcome of U.S.-China trade talks and President Trump’s decision on auto tariffs are among the biggest risks to trade for Japan.

Overall, 2019 so far has seen a wave of pessimism in regards to the global economy. Several G10 nations’ central banks have expressed negative outlooks for their respective economies which in turn have weighed down several currencies. In the midst of multiple trade conflicts, the yen has poised itself to be a must-have currency in times of uncertainty. Yen as an inconsistent currency will be a major theme in 2019, and as risk appetite ebbs and flows throughout the year, we will see the yen’s stability tested.