Han Dieperink: Mrs Watanabe breaks with the past

August 6, 2024

_{This column was originally written in Dutch. This is an English translation.}

By Han Dieperink, written in a personal capacity

The Nikkei index fell by 9.3% in the second half of the year up to and including last Friday, but thanks to the rising yen, the loss in dollars is limited to -0.4%. By comparison, the S&P 500 index has also fallen 2.1% in dollar terms over the same period.

The development of the yen in the past month had a major impact on the performance for foreign investors, who do not hedge the currency. The strengthening yen is not the result of the many interventions by the Japanese Ministry of Finance, but of the rapidly narrowing interest rate difference between Japan and the United States. Japan raised interest rates last week, while the market is now expecting a rate cut of almost 50 basis points in US rates for September.

Policy interest rate to 0.25%

The run-up to this week's Bank of Japan (BoJ) monetary policy meeting was messy, but the central bank's message about the yen was clear and honest.

Despite the BoJ's reference to a strengthening upward spiral between wages and prices and its previous pledge to move only if macroeconomic data justify it, the decision to raise the benchmark interest rate to 0.25% was not a given. So far, the BoJ has held back from adjusting rates to support the yen. This forced the Ministry of Finance to intervene directly.

Developed economies do not normally use monetary policy to influence their currencies, no matter how urgent the need or how painful the circumstances. The central bank's language is not yet explicit, but what happened on Wednesday marks a clear break with the past. The BoJ has tacitly admitted that currency is everything for the Japanese economy.

Mrs. Watanabe goes home

So if you want to go on holiday to Japan because of the cheap yen, you have to be quick. If a currency moves in the opposite direction once, this momentum can create an even stronger yen. In the world of currency trading, one name stands out, and that is Mrs. Watanabe. This is not the name of one person. She represents all Japanese housewives active in the global financial markets. They are a cultural phenomenon and have a major influence on both the Japanese and global markets.

Mrs. Watanabe symbolizes the average Japanese housewife. These women, who are responsible for their family's finances, looked for better options than the low returns offered by Japanese banks. They ventured into the fast-paced world of currency trading, which led to the creation of so-called carry trades. This strategy involved borrowing Japanese yen at a low interest rate and investing in foreign currency at a higher interest rate, making a profit from the interest rate difference.

But currency trading is full of dangers and pitfalls. Economic events can be very unpredictable, political developments and even natural disasters have a major influence on the development of the yen. When this unrest arises, Mrs. Watanabe repatriates her foreign investments and converts them into yen.

The strong demand for yen therefore ensures a stronger yen, which is why the yen was a safe haven for investors for a long time. After all, in times of unrest the yen rose due to this phenomenon. In recent years, the carry trade has been extra favorable because, in addition to the large interest rate difference, the profit on the short position could also be collected in yen. And every additional short position continued to weaken the yen, until it stops. Now that the yen has risen by 10% in a short time, short positions in yen will have to be covered.

Japanese economy

For Japanese businesses, sensitivity to a stronger currency should not be exaggerated. After the bursting of the double bubble in the late 1980s, Japan tried for a long time to weaken the yen in order to boost exports. When that failed, many Japanese exporters moved a large part of their activities to Southeast Asia in order to compete on the global market. That situation has not yet changed. However, Japan has retained a lot of foreign currency from previous interventions, while the Japanese government debt is largely domestically financed.

The Japanese economy is undergoing a major transformation with the end of deflation, the return of steady growth and renewed business dynamism. Moderate inflation and the best period of nominal economic growth since the collapse of the double bubble in the early 1990s mean that the lost decades are finally behind us. Large employers have thrown out the long-standing practice of neither raising wages nor raising prices and have begun a virtuous cycle of increases in both.

The change in the Japanese economy after two decades of stagnation is remarkable. Nominal GDP growth averaged 3.5% in 2022 and 2023, more than double the growth from 2013 to 2019. Japan did not grow on balance from 1993 to 2012, when nominal annual growth was negative 0.03%. In terms of inflation, Japan's consumer price index has risen 2% or more for 24 months in a row through March this year.

Improved corporate governance

Behind the positive economic headlines are a number of supportive trends. For example, wage growth has reached a 30-year high, while corporate governance reforms have helped improve returns on equity. In addition, policymakers combine monetary, fiscal, trade and industrial policies to increase economic productivity and improve sustainability. Many bank shares are not interesting to invest in, but Japanese banks are an exception.

Investors have long been skeptical of Japanese stocks due to poor corporate governance, but recent improvements could remove this stigma. Regulatory changes, initiated under Shinzo Abe and now under the influence of the Tokyo Stock Exchange, are aimed at improving capital efficiency, shareholder value and management accountability. Companies that implement changes in governance, such as improving the independence of the board of directors, see their share price rise.

In addition to the recent shift in business mentality, new developments could help Japanese companies, including a law encouraging domestic production of certain sensitive technology, as well as increased defense spending. And Japan appears to be benefiting from the desire of countries, including the US, to diversify production of key technology products.

More columns by Han Dieperink