Abenomics might underpin a weak yen but that doesn’t preclude a stronger one.
As investors seek to puzzle out which direction asset markets will take after a fractious start to 2016, perhaps it is still the case that “no-one who is really involved in the landscape ever sees the landscape”, as British author George Orwell once wrote.
Taking a step back might be the best way to understand the true meaning of the picture.
For example, while traders and Federal Reserve forecasts both see further US rate increases in 2016, the current yields on five- and 10-year US Treasuries have fallen back as money has flooded into the perceived safety of America’s government bond market.
Conventional logic would portray that as a flight to safety amid equity market volatility around the world. Even if there is an expectation of further increases in US rates this year, investors might plump for US Treasuries in the short term as a desire to guarantee the return of capital sometimes trumps the urge to maximise the return on it.
Of course, for those, such as Global Macro Investor’s Raoul Pal, who see the United States at high risk of entering recession, there is real value in buying US Treasuries even though the mainstream view remains for higher US interest rates and thus lower prices for the bonds themselves.
“I think the big surprise this year will be the strength of the [US] bond market … 10-years are likely to go to 1.2 per cent,” Pal tweeted on January 4.
Given the apparent robust pace of US job creation that is clearly a bold call but it might not seem quite such an outlier if the global economy falls victim to events in China as the latter adjusts to its “new normal” model of somewhat slower economic expansion.
“China has a major adjustment problem,” said billionaire George Soros on January 7. “I would say it amounts to a crisis. When I look at the financial markets there is a serious challenge which reminds me of the crisis we had in 2008.”
Whether China faces a crisis or not is a matter of considerable debate, but from an investor’s perspective, the landscape has shifted regardless of how things play out. For years, investors saw China as an obvious “buy”. That investment certainty is now a relic of the past.
And that change in perception itself forces change elsewhere.
London-based SLJ Macro Partners, in a January 5 research note, saw the US dollar “likely to be trending higher” versus the yuan, arguing “the pent-up private demand [in China] for foreign assets (both for diversification purposes and to discharge the existing dollar liabilities) will add to the depreciation pressures” on the Chinese currency.
But given that “hot money” doesn’t stick around when the temperature cools, capital that has flowed into China in the past decade is and will exit with potentially unexpected implications elsewhere.
Japan is a case in point.
The fiscal policies of Shinzo Abe’s government, combined with the ultra-accommodative monetary policy of the Bank of Japan, commonly called Abenomics, have created a landscape in which a weakening yen has been a characteristic feature.
Many Japanese investors and manufacturers, recognising the likelihood that the yen would be weaker tomorrow than it was today, sought better investment opportunities in a Chinese economy that offered both higher yields than could be found in Japan, and the prospect of capital appreciation as the yuan rose versus the yen.
Non-Japanese investors played the same game, using the yen as a funding currency to finance bets in China.
Investors must therefore decide if changed perceptions of circumstances in China lend themselves to a change in attitude towards the yen, even if Abenomics remains in full swing having still not fully succeeded in vanquishing deflation in Japan.
Thus, focusing on continued yuan weakness occasioned by capital outflows also necessitates considering where that money flows to. Abenomics might underpin a weak yen but that doesn’t preclude a stronger one, if the conditions are right.
It is not inconceivable that, in the event the yuan continues to depreciate, investors will recalibrate their view of the yen.
Repatriated capital might boost the yen’s value against other Asian currencies further while the Japanese currency holds its own even against the sought-after US dollar.
Clearly such a scenario, by strengthening the yen’s external value and so making imports into Japan cheaper in yen terms, would not assist the Japanese authorities in their quest to generate some price inflation, but it might be unavoidable.
In a changing global investment landscape, it will pay investors to think outside the picture-frame.