Yen Adds to Japan’s Economic Woes

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Economic conditions in Japan continue to deteriorate as today’s Tankan showed. The survey of large manufacturing firms declined to -3 from -1 the quarter prior as slowdown in Asia Pacific and especially China along with the relentless rise of the yen turned corporate sentiment dour in Q3 of this year. Although the result was a bit better than the -4 forecast, the Tankan recorded its third consecutive negative reading suggesting that economic conditions are showing no signs of improvement in the Land of the Rising Sun.

Japan continues to suffer from a perfect storm of negative factors as its export driven economy faces demand challenges in Europe, political conflict with China and the unyielding pressure of rising yen. Japan’s exports to Europe have fallen by 22% as the region’s sovereign debt crisis is wrecking havoc in the periphery economies depressing consumer demand drastically. In China, political furor over the territorial dispute over Senkaku islands has only exacerbated what was already slowing export market for Japan. Japanese multinational corporations such as Toyota have come under attack in China and have been forced temporarily suspend operations as hostilities flared up.

The sharp drop off in export income is beginning to take its toll on domestic demand, The BOJ survey of Japanese consumer sentiment worsened for the first time in four quarters in September as the number of people who said their incomes fell from a year earlier increased. The consumer sentiment diffusion index fell by 3.6 points to -43.1 in September after surging by 16.1 points to -39.5 in June. The present level was still much better than -55.6 reading in March and -57.5 in last December but it marks a step back as consumers retrench in the wake another possible contraction in Japan’s GDP this quarter.

Amidst, the challenging economic conditions for Japan, the rise in the yen has only served as salt on a wound for Asia most advanced industrialized economy. Japanese officials had continued to jawbone the market warning that the currency’s strength is not reflecting the underlying fundamentals, but their efforts have been for naught as USD/JPY continues to drift lower towards its all time lows driven primarily by interest rate dynamics between USTs and JGBs. One of the primary effects of Fed’s QE and Twist actions has been to depress US long term yields which in turn has kept USD/JPY below the 80.00 level despite deteriorating economic conditions in Japan.

The newly appointed finance minister Koriki Jojima will likely raise the issue of yen appreciation at the next G-7 meeting in Tokyo on October 11th, but unless Japanese authorities undertake dramatic policy actions such as vastly expanding their own QE program, USD/JPY is unlikely to rise above the key 80.00 level in the foreseeable future.

Boris Schlossberg
Managing Director

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