Hatoyama Yen Repels Goldman Seeing 8% Slide on Growth

Hirohisa Fujii, Japan’s new finance minister, says he doesn’t support a weak yen. The world’s biggest banks say that’s just what he may get.

While the yen gained against all but one of the 16 most- actively traded currencies since early August as the Democratic Party of Japan became the likely winner in national elections, forecasters say it will decline 5.2 percent against the dollar and 0.7 percent versus the euro by year-end. The economy is too weak to support a stronger rate, based on the median of 40 estimates in a Bloomberg survey.

Japan will be the only Group-of-10 nation that won’t raise borrowing costs in 2010, keeping its benchmark interest rate at a record low 0.1 percent, the survey shows. The economy will expand 0.8 percent next year after contracting 6 percent in 2009, according to median forecasts, putting assets in the world’s second-biggest economy at a disadvantage to those in countries with higher borrowing costs.

“Everyone is seemingly buying the yen, which I think is ridiculous,” said Jim O’Neill, head of global economic research at Goldman Sachs Group Inc. in London. “The true underlying fundamentals for the yen in my book have deteriorated significantly.”

New York-based Goldman Sachs, which earned more than $100 million from trading for a record 46 days last quarter, predicts the yen will weaken to 98 per dollar and 142 per euro by the end of the year, from 92.23 and 135.25 as of 7:09 a.m. in New York today. Bank of America Corp., the biggest U.S. bank, and HSBC
Holdings Plc, the largest in Europe, are even more bearish.

                           Yen’s Rally

The yen rallied 6.6 percent against the dollar and 3.3 percent compared with the euro as the Democratic Party of Japan, led by Yukio Hatoyama, 62, gained in the polls on the way to an election victory in the lower house of Parliament on Aug. 30 that broke 55 years of almost uninterrupted rule for the Liberal Democratic Party. Only the South African rand has risen more.

During the campaign, the DPJ said a stronger yen will boost household spending by making imported goods less expensive.
That’s in contrast to the former administration’s focus on public works spending and keeping the yen weak to help exporters.

Fujii, 77, reiterated that message on Sept. 16, the day the DPJ officially took over, saying he doesn’t support a “weak yen.” The comments drove the currency to 90.13 per dollar, its strongest level since February. The following day, he said it was an “absurd idea” that a weak yen is better for exports.

                       Suffering Exporters

Shares of Aichi-based automaker Toyota Motor Corp., which makes about 75 percent of its revenue outside of Japan, dropped 1.1 percent on the day of Fujii’s comments even as the Nikkei
225 Index added 0.5 percent.

In a Cabinet Office survey released April 22, exporters said they can remain profitable as long as the yen trades at 97.33 per dollar or weaker. A rising currency hurts exporters by making their goods more expensive to foreign buyers and reducing the value of profits earned abroad. Exports account for 12
percent of Japan’s economy, compared with 6 percent in the U.S.

Tokyo-based Canon Inc., the world’s biggest maker of office equipment, said in its latest financial report every 1 yen change against the dollar would alter its second-half operating profit by 4.2 billion yen ($46 million).
“Fujii’s words will come to haunt him,” said Richard Benson, who oversees $14 billion of currency funds at Millennium Asset Management in London. “The DPJ’s strong-yen policy will hurt the Japanese stock market, leading domestic investors overseas in search of returns, selling the yen in the process.”

                          Exports Plunge

Exports plunged at an unprecedented 26 percent rate in the three months ended March 31, contributing to the economy’s record 15.2 percent contraction in the quarter. The public debt is almost 200 percent of the  economy, compared with about 48 percent in the U.S., according to data compiled by Bloomberg.

The surplus in Japan’s current account, the broadest measure of trade because it includes investment, is shrinking relative to the size of the economy. The measure will fall to 2.1 percent of gross domestic product this year, based on median estimates in Bloomberg economist surveys, from 4.8 percent in 2007 and 3.2 percent in 2008. The household savings rate will drop to 2 percent this year from 3.3 percent in 2008 and more than 10 percent a decade ago, Goldman Sachs says.

                       Strength ‘Illusion’

     “Yen strength is an illusion with short-term investors,” said Tomoko Fujii, Tokyo-based senior currency strategist at Bank of America Securities-Merrill Lynch. The Charlotte, North Carolina-based firm expects the yen to weaken to 105 per dollar and to 158 per euro by Dec. 31. “They’re jumping to the conclusion that the government change will boost the yen, but that’s not the case because there’s no benefit in killing off the exporters,” she said.

Deutsche Bank AG, the world’s biggest currency trader, says the yen will rally to 80 to the dollar by year-end. U.S. interest rates near zero will encourage investors to finance purchases of higher-yielding assets with the U.S. currency at the same time that the improving world economy boosts demand for Japan’s exports.

“Yen is back,” Bilal Hafeez, Deutsche Bank’s London-based head of foreign-exchange strategy wrote in a report to clients on Sept. 17. “The yen may end up being the biggest winner against the dollar.” The three-month dollar London interbank offered rate, or Libor, fell below the comparable Japanese rate last month for the first time since April 1993. Dollar Libor was 0.29 percent on Sept. 18, while yen Libor was 0.35 percent, according to the British Bankers’ Association in London.

                          Options Bets

     Options traders are betting the yen will rise against all other Group of 10 currencies in the next three months. The cost of contracts used to bet the yen will appreciate versus the dollar are the most expensive relative to those betting on a decline since July 30, so-called 25-Delta Risk Reversals show.
     Japanese investors are showing less confidence in their currency. They bought the most foreign bonds in four years last week, purchasing a net 1.66 trillion yen in the period to Sept.12, according to Ministry of Finance figures released Sept. 17. The drop in short-term rates reduces the expenses of hedging purchases of foreign bonds, said Keiko Onogi, a Tokyo- based debt strategist at Daiwa Securities SMBC Co., a unit of Japan’s second-largest brokerage.

                       Exchange Rates

     Individual investors in Japan added to foreign currency mutual funds every month since January, according to Investment Trust Association data. Assets in the funds reached 26.9 trillion yen in August, the most since September and up from 20.7 trillion yen in January.

Bank of Japan Governor Masaaki Shirakawa told reporters in Tokyo on Sept. 17 that while stimulus measures, including buying $20 billion of government debt a month, have helped the economy,
policy makers are “not confident about the strength” of consumer demand “after those effects fade.”

The central bank is monitoring the exchange rate, which is contributing to a drop in inflation, he said. Consumer prices excluding food plunged at a record 2.2 percent pace in July while the jobless rate hit an unprecedented 5.7 percent the same month, government reports showed.

“The yen is inappropriately strong,” said David Bloom, global head of foreign-exchange strategy in London at HSBC. The government “will mind given the massively deflationary threat Japan is still facing,” he said.

HSBC, the biggest European bank, is telling its clients that the currency will weaken to 105 per dollar and 158 per euro by March 31.

                      Intervention History

     Japanese officials have responded to yen strength in the past by intervening in currency markets, including when Fujii was finance minister between 1993 and 1994. Authorities sold the currency on all four of the last five times since 1995 when the yen approached the 100-per-dollar mark to support exporters.

     The Bank of Japan, on behalf of the Ministry of Finance, sold a record 20.4 trillion yen in 2003 and 14.8 trillion yen in the first quarter of 2004, when it traded as high as 103.42 per dollar. The yen declined to an eight-month low of 114.88 versus the dollar in May that year. “I suspect the people at the Bank of Japan and the Ministry of Finance will start briefing Fujii on what he should and shouldn’t say,” said Neil MacKinnon, global macro strategist in London at VTB Capital Plc, an investment bank.

“Incoming policy makers often make a public view on a currency, only for it to be clarified, reviewed or withdrawn once their advisers have a word with them.”

(Source: Bloomberg News)