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Why the Yen Is Set to Weaken

Category: Money Market

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Why the Yen Is Set to Weaken


by Jack Crooks / Saturday, January 28, 2012

The problems facing Japan have been building up for some time. And I don't believe the coming negative impact on its currency can be delayed much longer. In today's column, I'd like to share with you the reasons why. 

Reason #1— Japan just recorded its first current account deficit since 1980 

As you can see in the chart below, Japan posted a trade deficit of 2.49 trillion yen in 2011, after the economy was hit by the price shock of oil and a slowdown in global growth.

There are two related points to consider here that should lead to a weaker yen:

•  Japanese industry is being hollowed out by the strong yen. The overvaluation of the yen makes Japanese products less competitive on international markets. As a result, many of the country's powerful manufacturers have moved much of their operations offshore and are threatening to move more.

•  A current account deficit means Japan will be importing capital. This is important as it relates to the second powerful reason below — it means Japan will need to make itself more attractive for international investors, and that usually comes in the form of higher interest rates.

Reason #2— Japan is quickly losing the ability to fund its huge debt needs with internal savings

The pool of savings in Japan is falling. The Japanese government will increasingly have to attract international investors to fund its own towering debt needs.

Consequently, interest rates on Japanese bonds will have to rise. And this may further dent growth prospects in Japan relative to the United States; helping make the dollar more attractive than the yen.

Normally, higher rates tend to help a currency. But in Japan it has been quite the opposite for many years. It goes to the artificial nature of the Japanese money market.

Just take a look at the following chart and you can see what I mean. For example, when interest rates on Japanese bonds shot up in mid-2008, the yen took a nosedive. And when interest rates fell in mid-2010, the yen's value soared. 


10-year Japanese Gov't Bond Yield versus Japanese Yen-U.S. dollar

Now take a look at the chart of Japanese yen — U.S. dollar. The pair recently tested near-term support.

CurrencyShares Japanese Yen ETF — FXY Weekly  

There is a long way for the yen to fall if I am right about this setup.


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