Is It Time to Trade the Yen?

Recovery driven by exports: In the third quarter Japan was able to slowly move into the recovery path with Q3 GDP rising 0.3% QoQ and industrial production stabilizing. The stabilization is mainly attributed to demand for Japanese exports which rebounded strongly. Japanese exports have lately shifted more and more towards Asian partners lead by China which is slowly overtaking demand from Japan’s classic partners the US and the EU.

Since Asian emerging economies did not carry the same leverage as their western counterparts, Asian economies remained rather resilient to the credit crisis with consumption still growing and with it demand for goods. However, the demand from China and the Asian tigers is only part of the story. It was the Global stimulus, unprecedented in size, that lifted Japanese exports not only to Asia but also to the US with the 'Cash for Clunkers' program supporting demand for Japanese autos. And indeed, in December Japanese exports and industry indicators continued to recover with Merchandise trade balance at ¥ 492.4B, vehicle sales rising 36% YoY and Tertiary index rising a modest 0.5% MoM.

So where is the double dip risk coming from? The Japanese economy still faces serious headwinds for growth with negative CPI capping corporate profits and falling capital expenditures restraining job creation, both spurring fears of an unsustainable recovery. The last two quarters are considered to be the climax of the stimulus effect and still, in Japan, capital expenditures fell -24.8% YoY (for Q3) and CPI fell -1.9% YoY for the month of December.

As the global stimulus programs which led consumer demand so far begin to unwind and their effect is slowly fading, Japanese exports, which in the last few quarters held the Japanese economy afloat, could fall back again. This could pull the Japanese economy back into negative territory.

So how should you roll the dice?

Announcement of a large stimulus: The stimulus announced by the Government at the beginning of the month is considered by investors as an appetizer no more. However an announcement of a large scale stimulus could elevate sentiment for the Japanese economy and therefore weaken the Yen as it involves effective money printing and it will encourage Japanese investors to sell the Yen in favor of higher yielding currencies.

Watch out of Negative CPI: If CPI figures will continue to surprise for the downside then Japanese bonds which currently yield close to zero will look attractive once again. This could lead Japanese investors to repatriate funds and create demand for the Yen once again.