Appreciation Amongst Negative Rates: Japan's New Dilemma
Japan’s tough economic sledding continues. The Land of the Rising Sun faces currency appreciation without the underlying fundamentals to support it. A myriad of issues have led to weak economic conditions in Japan, and the recent appreciation of the yen isn’t helping at all. In fact, it is a counteractive force to Japanese monetary policy, and is causing headaches for Japanese firms.
The issues with the yen largely stem from global equity markets that have been crushed since the beginning of 2016. Investors are flocking to the yen as a safe haven currency, while they wait out the turmoil that persists around the globe, including in U.S. equities markets. The appreciation of the yen is a detriment to Japanese exporters, and overall a net drag on Japanese GDP. Through most of 2015, the U.S. saw these same issues, but the U.S. was in much better economic shape to afford the currency appreciation. In 2015, the U.S. had one of the highest growth rates of any developed economy, whereas Japan at some points in 2015 experienced economic contraction. Furthermore, Japanese demographics will make it hard to escape the low growth, near deflationary economic environment that currently persists. Without much room for error in their GDP growth, Japan must now deal with a drag on their foreign trade capacity.
Another issue with the appreciation of the yen is the monetary policy that Japan currently has in place. Typically as interest rates rise in a country, its currency will appreciate. In Japan, however, they have the odd distinction of loosening monetary policy with an appreciating currency. In fact, Japan recently went into negative territory with their interest rate on deposits at the Bank of Japan. This factor has also pushed Japanese bond yields into negative territories. Most of the investors and depositors in the negative space will be large institutional groups seeking for a safe place to park money, but this has real implications for the economy at large, since we are seeing a simultaneous appreciation of the yen.
Overall, Japan faces a precarious position, particularly for its corporations that are engaged in exporting. As markets around the world face major headwinds, including commodities, equities, and credit, investors are seeking a safe haven currency. That safe haven has been the Japanese yen, which has driven the value of the yen up against the dollar and a basket of other world currencies. It appears, that unless markets abroad calm down, Japan may have to go back to the drawing board.