Friday, January 25, 2013

The big news is a weaker yen

It's nice that the U.S. equity market is making new post-recession highs, but one of the biggest things happening on the margin is the decline of the Japanese yen. 

The chart above offers some long-term perspective on the yen/dollar exchange rate, by comparing the spot forex rate against my calculation of the yen's Purchasing Power Parity. The yen hit an all-time high of 76 vs. the dollar just over a year ago, a value that I calculate was about 50% above its PPP. The yen, in other words, was extremely strong. A very strong currency is symptomatic of tight monetary policy, an environment that has prevailed for almost three decades in Japan. It's not surprising, therefore, that Japanese inflation has been zero or negative for the past two decades.

In the past few months there have been some big changes in Japan, with powerful political pressures being brought to bear on the Bank of Japan to adopt an aggressively accommodative monetary policy. That this may turn out to be successful in turning chronic deflation into some form of positive inflation is reflected in the yen's 14% decline—from 78 to 91—against the dollar in the past four months, most of which has occurred since mid-November. As the chart also suggests, there is plenty of room for the yen to weaken further against the dollar.

This next chart shows how the value of the yen has been an important factor driving the Japanese equity market. Beginning in 2007, the yen surged from 123 to its all-time high against the dollar in late 2011—a staggering increase of 62%. This coincided quite closely to the 55% decline in the value of the Japanese stock market over the same period. Tight money not only gave Japan a case of deflation, it severely depressed the value of the Japanese equity market. Now, with the yen down 13% since mid-November, the Nikkei 225 is up 26% in dollar terms—a remarkable reversal of fortune.

It's probably not a coincidence that spot commodity prices, as measured here by the CRB Raw Industrials index, are up over 9% since November. The outlook for Japan's moribund economy is improving as the yen weakens, which in turn is likely whetting the Asian region's appetite for commodities. The weaker yen seems to be improving the outlook for the U.S. economy as well, with the S&P 500 up 11% since mid-November.

As the chart above shows, since peaking early last year, commodity prices have lagged significantly the rise in gold prices. It could be that commodities now have some catching up to do (they would need to rise by as much as 40% to reestablish their former relationship with gold), and the latest rise is just the first chapter in that story.

I don't pretend to fully understand all of this, but the relationship between the yen, equities, and commodity prices is too powerful to ignore. 


William said...


Annual 2012
Total Equity Fund Outflows -$18.1 Bil;
Taxable Bond Fund Inflows $299.6 Bil
xETFs - Equity Fund Outflows -$129.2 Bil;
Taxable Bond Fund Inflows $257.8 Bil

Monthly December
Total Equity Fund Outflows -$20.7 Bil;
Taxable Bond Fund Inflows $4.1 Bil
xETFs - Equity Fund Outflows -$55.6 Bil;
Taxable Bond Fund Inflows $5.7 Bil

Quarterly Q4
Total Equity Fund Outflows -$42.7 Bil;
Taxable Bond Fund Inflows $50.8 Bil
xETFs - Equity Fund Outflows -$82.5 Bil;
Taxable Bond Fund Inflows $46.7 Bil

William said...

AAII Sentiment Survey

Bullish 52.3%
up 8.4
Neutral 23.4%
down 5.3
Bearish 24.3%
down 3.1
But what are they doing with their money??


Week of 01/23/2013

Equity Fund Inflows $2.9 Bil; Taxable Bond Fund Inflows $3.9 Bil
xETFs - Equity Fund Inflows $3.7 Bil;
Taxable Bond Fund Inflows $3.5 Bil

Week of 01/16/2013

Equity Fund Inflows $286 Mil; Taxable Bond Fund Inflows $4.6 Bil
xETFs - Equity Fund Inflows $3.8 Bil;
Taxable Bond Fund Inflows $4.2 Bil

Public Library said...

I've been short JPY long CAD for a while now. The decline of Japan is one of my decade long themes. Poor demographics, immigration policy, public works deficits, crony capitalism, and finally the BOJ throwing in the towel. To me it points to a bleak and uncertain future despite the rallies and selloffs.

Benjamin Cole said...

Japanese deflation?

Remember, six of the last eight CPI reports in the USA have been negative. Deflationary.

Anonymous said...

Eighty-five billion a month isn’t exactly tight monetary policy. Much more looseness and they are going to have to give houses away with negative mortgage interest rates and send checks in the mail to everyone.

Benjamin Cole said...

Joseph Constable:

If money is not tight, how do you explain the deflation in six of the last eight CPI readings?

Crickey! I can remember when Volcker was lionized as an inflation fighter---and he brought inflation down to 4 percent to 5 percent range.

Now we log in at sub-zero inflation, and people say money is loose.

Anonymous said...

How can creating money supply of $1 trillion a year not be loose monetary policy? Even if credit was deleveraging at a rapid pace, this is a lot of policy. But credit seems to be growing so we are left with low velocity being the problem. Something is different. Low interest rates and people save more to make up for it. Inflation taking a bite out of household budgets people save more to make up for it. I don’t see rising general prices as being a solution to low velocity. I don’t see inflation as a solution to the rising cost of doing business as businesses have become agents of social engineering. Companies just push for more productivity to offset inflating costs.

McKibbinUSA said...

For the record, much of the US is in economic depression -- the proof thereof includes: a) the long-term declines in real working wages; b) the long-term declines in real property values; and c) the long-term decline in the employment to population ratio -- the fact that the Fed is adding to the money supply does not change the facts about the ongoing economic depression in America, especially along Main Street -- those who argue that Fed accommodation is inflationary are correct, which is exactly the correct monetary medicine during times of economic deflation -- folks, the US is in a state of economic depression evidenced by the facts cited above -- to think otherwise does not pass the laugh test...

McKibbinUSA said...

PS: I will acknowledge that the very beginnings of an economic recovery are starting to appear -- however the recovery does not convert to "recovered" until after the US sees extended long-term indications of topping the former highs in real working wages, real home values, and the employment to population ratio -- my guess is that the US is still 20-30 years away from reaching a "recovered" economic state -- anyone currently in retirement will likely never see a full economic recovery in the US during the balance of their lifetimes.