Japanese companies bet on yen recovery from Brexit levels

A man holds a Japanese 1,000 yen banknote as he shops at a store in Tokyo.
Tomohiro Ohsumi | Bloomberg | Getty Images
A man holds a Japanese 1,000 yen banknote as he shops at a store in Tokyo.

As the yen cracks below 100 for the first time since the Brexit vote, Japan's largest companies are betting the currency will recover and boost profits.

For 20 Japanese companies with a market cap of more than $15 billion, the average forecast for dollar/yen was 107.2 by March 31, 2017, according to analysis of their latest earnings reports by AlphaSense, a financial search engine.

Some on Wall Street agree with that view. UBS expects the yen to reach 104 versus the U.S. dollar in the next three to six months, and 107 in the next 12 months. Bank of America Merrill Lynch is even more optimistic with expectations the Japanese currency will reach 105 by year-end and 115 by the end of next year. The yen briefly fell below 100 against the dollar Tuesday morning to hit its lowest since June 24, after the surprise U.K. vote to leave the European Union.

"Definitely the Bank of Japan is not comfortable with these levels of dollar/yen and will fight back, and the Fed will hike," said BofAML's head of G-10 FX strategy in Europe, Athanasios Vamvakidis. He noted the combined pressures should support the dollar and halt further strength in the yen.

Most analysts attributed much of the recent strength in the yen to weakness in the dollar as expectations for the next Federal Reserve interest rate hike have been pushed out. The concern has been if the yen strengthens too quickly against the dollar to break 100, the Bank of Japan might intervene as it finds monetary policy increasingly ineffective in weakening the currency.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, noted there is a large coupon payment from the U.S. Treasury every year in August. Since Japan is the largest holder of U.S. debt, it may be repatriating some of those funds, removing other higher-yielding debt rather than hedging new positions, given the cost of dollar-denominated investments. He also said there were $54.56 billion in bond maturities.

For much of this year so far, the trajectory of the yen has been stronger against the dollar, not weaker, and a wrong view on the currency could cut further into the profits of export-focused Japanese companies.

"They're betting the Bank of Japan will be very aggressive and it'll work and so far they've been wrong," said Ilya Feygin, managing director and senior strategist at WallachBeth Capital. "And if they're going to have to revise down their forecasts they'll have to revise down their earnings as well."

A prime example of the pressure from the strong yen is Toyota Motor. In its latest earnings report, the automaker said it expects the strengthening yen to hit fiscal full-year profits by 1.12 trillion yen ($11.1 billion). Toyota, which is the third largest in the U.S. market by sales, cut its full-year earnings forecast to 1.6 trillion yen versus the prior estimate of 1.7 trillion yen.

The AlphaSense analysis of 12-month dollar/yen forecasts showed Toyota and Panasonic were on the stronger end with estimates of 102 yen versus the dollar, while pharmaceutical firm Eisai had the weakest forecast at 113.

Last December, the yen was near 120 against the dollar. Trouble with the persistently strong yen picked up in late January, when the Bank of Japan surprised markets by cutting interest rates to negative for the first time. Rather than weakening the yen, the currency soon strengthened as geopolitical uncertainty sent investors into the risk-off trade of buying the yen versus the dollar.

The trend climaxed in late June after the Brexit shock briefly sent the yen below 100 against the dollar for the first time since 2013. The Japanese currency was near those levels again early Tuesday as the U.S. dollar index temporarily traded more than 1 percent lower amid the latest Fed commentary.

San Francisco Fed President John Williams said in a paper Monday that central banks might have to raise their inflation target. However, he is not a voting member of the Fed's rate-setting committee. Voting member and New York Fed President William Dudley said early Tuesday on the Fox Business Network that a rate hike could come as soon as September if data supported a move.

"The world could live with higher U.S. rates," Chandler said. He said there has been a view that Fed rate increases would destabilize the world economy. "I think a Fed rate hike would help the world economy because some other central banks are relying too much on monetary policy stimulus," he said.

Meanwhile, investor focus remains on Fed Chair Janet Yellen's scheduled remarks at the central bank's annual conference at Jackson Hole, Wyoming, on Aug. 26.

"If we see a major shift in chatter around the dollar, these Japanese companies that actually expect a softer yen, they'd need to rethink their policy," said Andres Jaime, global FX and rates strategist at Barclays, which expects the yen to fall closer to 90 versus the dollar by December.

He said continued geopolitical uncertainty around regions such as Europe and China will increase volatility and support risk-off flows into the yen versus the dollar, while the BOJ appears to be out of tools to stem the strength in the yen.

The Japanese central bank has tried a slew of stimulative measures, including cutting rates to negative territory earlier this year and purchasing billions in exchange-traded funds. Meanwhile, Prime Minister Shinzo Abe's Cabinet announced this month a 13.5 trillion yen economic package.

"The easing measures of the Bank of Japan of the last few months have not fully succeeded in getting the market betting on future yen weakness," said Constantin Bolz, director of FX strategy at UBS in Zurich. "But for us, what they've done in the last few weeks with the fiscal package and monetary package at the same time could potentially change that."

Both the Fed and BOJ meet next on September 20 and 21.

As Japanese companies struggle from currency headwinds, they also face pressure from slow growth. Earlier this week, Japan reported preliminary second-quarter annualized GDP growth of 0.2 percent, below the revised 2 percent rate of the prior quarter. Exports to the major Chinese, U.S. and EU markets continued to decline in June.

The stocks of many Japanese companies that are household names in the United States have fallen sharply and hit the Nikkei 225, which is 12.8 percent lower for the year so far. Sixty-seven components have lost at least 10 percent so far this year, with 27 of those down at least 20 percent.