Japan has an inflation problem. To address that problem and manage inflation expectations, the Bank of Japan (BOJ) needs to continue to hike rates. Meanwhile, the yen has been undervalued and underowned. However, the underappreciated yen’s prospects may be changing.
Of course, currency moves recall last year’s unwinding of the yen carry trade, which upended markets. Why should things be different this time around? In the middle of last year, the US economy and labor market were weakening. Although there are concerns about the potential impact on US growth and labor from the new administration’s trade and immigration policies, growth and the job market are somewhat resilient for now. Instead, there appear to be other factors in place. Japan’s inflation problem is more structural in nature, which puts the BOJ in the position of needing to hike rates while other central banks in the developed world are still more biased toward cutting rates. So, rate differentials are moving in favor of the yen. Put another way, the yen generally is a proxy for US and Japanese monetary policy, and that spread is narrowing.
While we remain biased against Japanese government bonds, we continue to be constructive on the yen. We believe the currency stands to appreciate as the BOJ is forced to continuously address Japan’s inflation problem later this year, or perhaps sooner if inflation continues to accelerate or the yen depreciates further. While BOJ policy shifts often come at a notoriously slow pace, in recent days appreciation in the yen has come faster through an uptick in buying interest due to rising uncertainty in risk markets. These moves have resulted in a shift in Commodity Futures Trading Commission (CFTC) net positioning among institutional asset managers toward extended long positions in the currency. Tactically, the yen could give back some of this recent appreciation if risk bounces back. Even so, the medium-term outlook is not altered, as the narrowing trend of US-Japan rate differentials persists, which will eventually continue to drive the yen stronger. And if the risk-off trend deepens, the yen may see faster appreciation.
Carol Lye‡
Portfolio Manager & Senior Research Analyst
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‡ The Brandywine Global Singapore-based team is a division of Templeton Asset Management Ltd, a company incorporated in Singapore.
Groupthink is bad, especially at investment management firms. Brandywine Global therefore takes special care to ensure our corporate culture and investment processes support the articulation of diverse viewpoints. This blog is no different. The opinions expressed by our bloggers may sometimes challenge active positioning within one or more of our strategies. Each blogger represents one market view amongst many expressed at Brandywine Global. Although individual opinions will differ, our investment process and macro outlook will remain driven by a team approach.
