Yen Squeezed Higher

The renewed pressure on emerging markets is seeing short yen positions squeezed again.  The yen is easily the strongest currency on the day, rising about 0.75% against the dollar.  This month, it has risen a little more than 3%.  The New Zealand dollar is the second strongest currency this month, gaining about 0.75% against the dollar.  The RBNZ meets later today and there is a chance, though diminishing, of a rate hike. 

Gross yen futures positions have been gradually falling for the past four reporting weeks.  Though last week's report, the short yen position had been reduced by about 20%, though still was at a lofty 128k contracts as of January 21.  We suspect more shorts have been covered.    The yen was partly used as a funding currency and these positions are being unwound.  

Japan reports December retail sales first thing in Tokyo on Thursday.  A small 0.3% gain is expected after a 2.0% rise was seen in November.  There is some thought that ahead of the sales tax hike on April 1, retail sales may be buoyed.    Friday Japan reports unemployment, but also, arguably more importantly, given the aggressive quantitative easing, the latest inflation readings.  CPI appears to be stabilizing after the big run up last year and, if so, may spur more talk that the BOJ will have to do more, if it is going to reach its 2% inflation target. 

Some  have expressed concern that the Japan is exporting deflation.  It is true that US import prices form Japan have fallen almost 4% since October 2012, the eve of Japan's election call that led to the return of Abe.    During this time, the yen has declined by about 22%.  

Industry reports suggest that Japanese contract prices have remained broadly unchanged.  The dollars earned from exports and/or local sales are sufficient to generate higher yen revenue.  The depreciation of yen on trade weighted terms simply corrects the overshoot and is now back to level seen form the late 1990s until the financial crisis.  

Earlier this week, Japan reported a larger than expected December trade deficit and a record large deficit for the entire year (JPY11.5 trillion or ~$112 bln).  This is larger than the combined shortfall in 2011 and 2012 (~JPY9.5 trillion).    

Japanese companies, like European-based companies typically, when hit with an exchange rate shock, do not pass it along very quickly or very much to customers.  They typically compete in terms of market share, not profit share.    Japanese export values have increased more than volumes and the increase in volumes can be largely explained by increased world growth.  

The decline in the yen has boosted the cost of imports, especially energy (though volume are not increased very much), more than it aided exports.  Nevertheless, there is increased pressure from the US Congress to raise the importance of currency issues in negotiations over the Trans-Pacific Partnership trade deal.  

Tokyo elects a new governor on February 8. Former Prime Minister Hosokawa is challenging Abe's candidate Masuzoe, a former health minister.  Hosokawa is being supported by former Prime Minister Koizumi, and old ally of Abe's, and the opposition DPJ.   He is campaigning on a platform that calls for the permanent closure of Japan's nuclear facilities, none of which, incidentally are in Tokyo.    This raises questions about the ability of Hosokawa, even if he were to win, to influence the national debate over nuclear power. 

The country's 50 reactors have been shut down.    A mid-January poll found that in Japan 42% are opposed to nuclear power and 21% are in favor it.  A full third are undecided.  The latest polls suggest Abe is drawing support from a little more than 50% of the voters.  Anecdotal reports suggest Hosokawa is behind Masuzoe.  

Japanese government officials are hoping that as many as five nuclear plants can re-open later toward midyear.  The plants under review  by the Nuclear Regulation Authority that are hoped to resume operation are mostly in the south, where a number of industries are concentrated. 

In a weak yen environment, one would expect Japanese multinationals to source more of their output in Japan.   In addition, Abenomics is partly to aimed at encouraging investment in Japan to boost its growth potential.  This does not appear to be happening very convincingly.  

Take the important auto sector as an example.  Even though the yen weakened in 2013 for the second consecutive year, Japanese car makers boosted their North American output, with Toyota and Honda producing record volumes.  Indeed, exports from their US plants to Asia (e.g. South Korea) and Latam also increased.  Nissan Motors is expanding North American output as part of its longer-term strategic plans and to help purposely build-in redundancies in supply chains. 

The dollar hit a low just below JPY101.80 at the start of the week.  That was the lowest level since early December.  The dollar held the JPY102 level on the back of the renewed pressure on emerging market currencies.  The JPY102.60-80 offers the near-by cap.  On the downside, below the week's low is an objective near JPY101.50 and then JPY101.  Weak emerging markets, weak US and Japanese equities and firm US bond yields, coupled with a still large short yen position out there, warns that the yen bears may not have easy ride.