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Solving the yen puzzle

The Japanese yen has been a star performer in 2016, and after a 20 percent move in less than eight months, everyone is wondering where this currency goes next.

It's a question being asked far beyond foreign exchange desks.

A stronger yen is helping some American multinational companies, including technology players like HP Inc. and automakers like General Motors that have complained in the past about a weaker yen giving a lift to their Japanese competitors' exports and an unfair competitive advantage.


Japanese Yen
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Those American executives may be comforted by the yen's recent show of strength. The currency has steadily climbed, up 9 percent in the last three months against the dollar and 20 percent this year.

As the yen has strengthened, strategists have become increasingly skeptical of the ability of the Bank of Japan and the Ministry of Finance to control it and reverse the gains.

"The rates tool failed to weaken the yen in January, the fiscal package has been already announced and the marginal efficacy of [quantitative easing] is decreasing, while the Japanese Government Bond market is drained … [so] reversing yen gains will prove challenging," writes Olivier Korber of Societe Generale Cross Asset Research.

In January, the Bank of Japan shocked the market by cutting interest rates into uncharted negative territory, and instead of having the desired effect of weakening the currency, the yen strengthened. That raised questions about whether the central bank had any ammunition left to fight years of economic weakness and a strengthening currency.

Still, the central bank could try again.

BOJ Governor Haruhiko Kuroda told the Sankei newspaper this week: "Technically there definitely is room for a further cut." Kuroda could also enlarge the central bank's massive 80 trillion yen (or nearly $800 billion) annual QE program when it meets Sept. 20-21.

However, that, too, may fail to deliver any real yen weakness.

"Our analysts in Tokyo do not expect further easing to be delivered in September, but even if it is delivered, we doubt that more of the same easing measures will prove effective at re-weakening the yen on a sustainable basis" Bank of Tokyo-Mitsubishi strategist Lee Hardman wrote in a recent note.

Another sign the yen has more room to run?

The currency's surge is happening during a period of relative calm for broader markets. Historically, investors sell the yen when market volatility remains low and they buy it as a safe haven during episodes of crisis, volatility and risk aversion.

Remember the days of panic following Brexit? The yen soared amid a global market sell-off. But as stocks have since recovered, surging to record highs, the yen has actually strengthened back to post-Brexit fear levels.

The fact that the yen is surging at the same time the CBOE Volatility Index sits at multiyear lows is very unusual according to Kathy Lien of BK Asset Management. "It suggests we could have a volatility spike that leads to more yen strength," she said.

So what could stand in the way of a stronger yen?

One risk is central bank intervention, which last happened in 2011 when the Bank of Japan stepped into the market to sell the yen, but ultimately it didn't work and the market impact was short-lived.

Lien and other strategists suggest that 95 is the critical level that could trigger intervention and that "most certainly could cause a big squeeze given the [large] amount of long yen positions … but just like every other intervention attempt it will come right back down." (The yen was at 100.23 to the dollar on Wednesday.)

Furthermore, Japan may refrain from intervention this time to stem the yen's gains because of the upcoming U.S. election. With talk of trade protectionism on the rise in both parties — and countries such as China and Mexico under fire from Republican presidential nominee Donald Trump, who accuses them of manipulating their currencies and cheating American workers — Japanese authorities may decide to avoid any political scorn on the campaign trail.

The other factor that could stand in the way of a stronger yen is the Federal Reserve. If Chair Janet Yellen hints at raising interest rates in a widely anticipated speech in Jackson Hole, Wyoming on Friday, that could send the dollar higher across the board, including against the yen. Better U.S. economic data could have the same effect on the currency pair.

Ultimately, strategists say, that shouldn't change the yen's long-term trajectory and the country's economic fundamentals.

"I think that what is driving the yen — mostly Japanese lifers, pensions, corporates hedging their foreign investments or dollar assets — may not be blunted by prospects of higher [U.S.] rates," said Marc Chandler, chief FX strategist at Brown Brothers Harriman.

Bottom line, American companies are breathing a sigh of relief thanks to the yen's sharp jump, and that relief may last for the foreseeable future.

But when it comes to currency predictions and moves, keep the advice of Bonnie Baha, the markets expert and DoubleLine portfolio manager who tragically died in a car crash this week, in mind. She told me last year, in reference to the strong dollar: "Doesn't mean it's going to be a straight line, but markets rarely work that way, right?"