The yen is rising yet Japan’s economy is slumping. Call it pandemic economics

It might seem odd that an economy with as many problems as Japan’s should have a currency that enjoys safe-haven status. But, whenever international tensions rise or the global outlook darkens, the yen tends to appreciate

Neal Kimberley

Published: 5:15am, 23 Sep 2020

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Japan is the land of the rising yen even as its economy slumps. Amid the coronavirus pandemic, Japan’s economy shrank by an annualised 27.8 per cent in the second quarter of 2020. Long-serving prime minister Shinzo Abe has stood down for health reasons while, more generally, it would logically seem that Japan, with its ageing population, is more vulnerable to a virus that is more dangerous to the elderly.

One person in every 1,500 in Japan is now aged 100 or older, and 28 per cent of Japanese are 65 and above. Only 12 per cent are under 15.

That sounds like a recipe for a perfect economic storm that would normally be associated with local currency weakness. Yet, the foreign exchange market currently likes the Japanese yen.

Japan’s currency hit a seven-week high against the US dollar last week, while also making some gains versus other currencies such as the Australian dollar, the British pound and the euro. That’s clearly yen strength and not just US dollar weakness.

Japan’s new Prime Minister Yoshihide Suga has plenty to think about, and no doubt Japan’s influential export sector will be bending the ears of policymakers about the risk to the country’s competitive advantage that is represented by a rising yen.

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A certain degree of yen weakness arguably sprang from the economic policies of Suga’s predecessor but even if the new government embarks on another phase of so-called Abenomics, markets might take some convincing that further rises in the value of Japan’s currency are unwarranted.

Bank of Japan governor Haruhiko Kuroda said last week that it would “take measures to ease the strain from Covid-19”, which would mean continuing with “powerful monetary easing” and striving to support the economy and achieve the central bank’s price target.

In its dogged but so far unsuccessful decades-long attempt to reignite inflation, the Bank of Japan has written and rewritten the central bank playbook for ultra-accommodative policy, so continuing evidence that it remains resolutely determined to pursue its price target might ordinarily weigh on the value of the yen.

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But these are not ordinary times, and during the pandemic, many major central banks (though notably not China’s) have adopted, and extended, monetary policies first developed by the BOJ to address Japan’s situation.

Consequently, in a pandemic world, Japanese monetary policy no longer appears notably more ultra-accommodative than that of other major economies such as the euro zone and the United States.

This has implications for Japan’s investors, who have long pursued higher yields in overseas bond markets than were achievable with Japanese government bonds.

Given that, in many cases, overseas government bond yields have now also become derisory (but, again, not in China), Japan’s investors could decide that they might as well just repatriate some of their money, eliminating the foreign currency risk for them in the process.

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Then there’s the issue of the Japanese yen as a safe-haven currency. It might seem odd that a country with as many economic problems as Japan should have a currency that commonly exhibits safe-haven characteristics but that’s how the market sees it. When international tensions rise or the outlook for the global economy darkens, Japan’s currency tends to appreciate.

And there are plenty of international tensions at present, while the pandemic does lend itself to a fairly gloomy global economic outlook. The currency market is not oblivious to these yen-supportive possibilities and could well “pre-position” for these outcomes.

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After all, the art of the trade always lies in recognising what the crowd will do before the crowd itself knows and, in any currency play, it’s not where the price is that matters, it’s where it’s going to be.

Markets may deliver yet more yen strength whether policymakers in Japan like it or not, and Tokyo doesn’t have a lot of levers it could pull to stop the yen from rising.

Intervention in the currency market to stem yen appreciation may have been a preferred tactic of the Ministry of Finance in years gone by but it’s hardly a realistic option with Donald Trump in the White House and a United States presidential election in November.

Nor is it likely that whoever occupies the Oval Office next would be prepared to tolerate attempts by Tokyo to resist yen appreciation. After the election, a weaker greenback may well suit the White House as it attempts to re-energise a post-coronavirus US economy and create jobs.

The Japanese economy has many problems but, for now, Japan is the land of the rising yen and it could well remain so.

Neal Kimberley is a commentator on macroeconomics and financial markets

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