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New Finance Minister Fukushiro Nukaga Has an Itchy Trigger Finger for Defense - Will he Pull it out in Defense of the Weak Yen?

In Monday’s Cabinet shakeup, Finance Minister Koji Omi was replaced by Fukushiro Nukaga, a Waseda University graduate (for those of us who care) and longtime LDP member of the Lower House. Back in 1998, Nukaga served as head of the Japan Defense Agency, though he resigned from that post due to a political scandal. In 2000, then Prime Minister Yoshiro Mori named Nukaga as Minister of State in charge of economic and fiscal policy, though he resigned from that post due to another scandal involving political fund contributions. From October 2005 to September 2006, he served once again as head of the Japan Defense Agency under Prime Minister Koizumi, and left the post when Mr Koizumi’s term as party president expired.

Nukaga has also served as Chairman of the Standing Committee on Finance in the Lower House, as well as twice having held the post of Deputy Chief Cabinet Secretary.

In a January 2006 speech at the Royal United Services Institute for Defence and Security Studies, then Defense Agency Chief Nukaga told his audience:

Japan will develop multi-functional, flexible and effective defense forces in order to cope with new threats and diverse contingencies and to participate proactively in international peace cooperation activities. New threats cannot be effectively dealt with under the traditional concept of deterrence as during the Cold War. Therefore, a transformation of defense forces from deterrence-oriented to response-oriented forces should be further pursued.

Turning to his current post. We know that Japan has not intervened directly in global currency markets since the spring of 2004. In a press appearance on Thursday, Nukaga told reporters, “We must make efforts to avoid drastic changes of foreign-exchange rates to ensure that the economy maintains sustainable growth.”

While that may hint at a possible departure from the path of his predecessor (though do no more than just hint), one thing remains consistent with former Finance Minister Omi’s line of thinking. Nukaga, like his predecessor, seems opposed to the idea of using some part of Japan’s massive foreign reserves as an investment vehicle. At the same press conference on Thursday, he also told reporters:

The priority of foreign-reserve management is to ensure the stability of currencies. We must carefully think before making risky investments.

That, of course, is a carefully worded way to not say yes or no, which is what we should expect from Mr Nukaga until at least his first meeting as a member of the Council on Economic and Fiscal Policy, which is still listed as ‘to be determined’ on their website…

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The Nikkei Gives Us the “Told Ya So” Piece We’ve Been Waiting For

From the Nikkei:

When the yen shot up to the 113-114 range to the dollar soon after breaking the psychological mark of 115 on Thursday, it was not U.S. and European hedge funds that were seen desperately buying yen but Japanese housewives and other individual investors…

…[I]ndividual traders continued to sell yen even when hedge funds were unwinding their carry trade positions. When the yen rose sharply, they were forced to buy back the Japanese unit at a loss.

Trading systems broke down at two margin trading firms because of a sharp rise in order volume. Some firms were even temporarily unable to display cross forex rates on their electronic boards because of market volatility.

Those who were unable to execute their desired transactions might come to distrust the market system as a whole. And it remains to be seen whether individual investors, many of whom have now suffered significant losses on margin trading, will resume selling yen right away.

Of course people got burned. But so did the Nikkei by not backing up this piece with some numbers that actually relate to the conclusion in the first paragraph.

There were plenty of housewives out shopping and spending money today in Omotesando, that’s for sure. Let’s see how this effects August retail figures when they come due…

Sunday Reading: Morgan Stanley’s Stephen Jen on Risk and the Yen

If you’re in there trading yen right now, you will most likely be interested in what Stephen Jen has to say in a piece entitled Risk Reduction and the JPY over at the Morgan Stanley Global Economic Forum. Here are two quick bits:

Reduction of the ‘JPY carry trades’ may continue for a while, we concede. We have long argued that the primary type of outflows from Japan’s retail sector are not ‘carry trades’ – trades whose key motivation is interest rate differentials – per se, but investors’ desire to diversify their portfolios and take on more risk.

…[W]e still believe that Japan’s preference for risk has gone through a structural shift. With US$13 trillion in liquid financial assets and 50.5% of this in cash deposits, the scope for Japanese retail investors to diversify into risky assets is immense. (Note: If Japan reduces its cash deposits by 1% of total financial holdings a year, this translates to US$130 billion worth of ‘conversion’ from cash to risky assets a year, or a little more than US$10 billion a month.

It’s too bad we don’t have any numbers to stick on those, but the piece is somewhat of a summary. I think it would be important to look at the demographics behind those liquid assets and cash deposits. There will be a certain chunk of them that will never, ever be anything other than cash deposits, as they are held by older retirees who would never, ever risk even a single yen of their hard-earned capital.

It seems as though this considerably reduces the amount of money that we should consider as ‘cash deposits’ for the purpose of possible investment capital, as a hefty percentage of that amount is simply inheritance tax to-be.

At any rate, get over there and read Jen’s piece…

Yen moves up to 112, briefly

I think it’s worth a mention that the yen briefly moved into 112 territory during trading in New York overnight. This will be good news for some and bad for others, though we haven’t heard much other than rumblings about the carry trade as of late…

In case you were worried, the Financial Services Agency is going to start checking financial institutions in order to assess their level of exposure to subprime loans.

One of the stated goals of the FSA’s check is to ensure that financial institutions have “proper risk controls in place.”

Carry Trade Watch: Tokyo-based Forex Trading up 19.2% in April

This just in from the Nikkei: In April, average daily forex trades in Tokyo surged to 240.3 billion dollars, up 19.2% from a year ago. Of that total, trades executed by non-Japanese entities accounted for 167.1 billion dollars, which was up 31% against April 2006.

Trading in the South African Rand, which provides far better interest rate and bond yields than the yen, was up 50% year on year.

Despite the boost in the amount of Tokyo-based forex trading, the Nikkei tells us that, “Tokyo trading still pales in comparison with Europe and the U.S. In London and New York, the figures came to 967 billion dollars and 487.9 billion dollars as of October 2006.”

Japan’s June Trade Surplus up 53.4%

According to preliminary data released by the Ministry of Finance yesterday, Japan’s trade surplus surged ahead 53.4% in June compared against June 2006. During that period, exports were up 16.2% and imports increased by 10.7%. By region, the middle east saw the greatest percentage increase, up by 55.8% to 239.2 billion yen. Japan, however, still holds a trade deficit in the region, primarily due to oil imports from Saudi Arabia and the United Arab Emirates.

Exports to Asia, however, led the boom, surging 16.2% to 3.542 trillion yen in June. Exports to Vietnam and India, nations which have been heavily visited by Ministry of Foreign Affairs officials, especially over the past year and a half, saw the greatest gains in terms of percentage, at 34.8% and 39.4%, respectively. Earlier in July, Truong Vinh Trong, the Deputy Prime Minister of Vietnam, had lunch with Foreign Minister Taro Aso, where the two discussed the necessity of judicial reform for Vietnam’s economic development and continued integration into the world economy. And last October, when Nguyen Tan Dung, the Prime Minister of Vietnam, met in Tokyo with Prime Minister Shinzo Abe, the two leaders agreed to begin negotiations on a Japan-Vietnam Economic Partnership Agreement, which began in January and are still ongoing.

Economic relations with India were ramped up during the Koizumi administration, with then Foreign Minister Yoriko Kawaguchi making two trips to that nation during her short tenure in Kasumigaseki. Since Shinzo Abe has come to power, discussions between the two nations have continued, with Abe asserting that Japanese firms need to establish greater presence in India.

Thus, we expect to see continued growth in Japan’s economic partnerships with these two nations.

Getting back to the report on trade: On Wednesday, the Foreign Ministry also announced that January-June 2007 figures showed a 59.3 percent increase versus the same period last year. Again, this is in yen-valued terms. Over this period, exports jumped 12.8% to 40.36 trillion yen while imports climbed 8.2% to 35.23 trillion yen. For the second consecutive half-year period, Japan’s total trade with China exceeded that with the US. Also notable was that trade surpluses with both China and the US declined over this six-month period.

So, why the massive growth in value of the trade surplus? I had been set to write a bit about the yen’s weakness and how that has affected (distorted?) the results, but Edward Hugh has already put together an admirably written post on this. Regarding the June statistics, Mr Hugh points out that:

…[W]hile exports climbed 16.2%, imports gained only 10.7% which was significantly below market expectations. The weaker import reading reflects both the weakness in the yen (and hence the relative cost of imported products) and ongoing weakness in domestic demand.

Well said. Those expecting to import to Japan need to be careful at this stage. With the market drying up (and a possible consumption tax hike on the horizon), it will take carefully niched, well marketed products to really stand out. Protectionist forces, of course, may rear their ugly head and it make take some more creative, outside the box thinking for importers to establish a foothold in this market.

With that out of the way, Mr Hugh gets on to the meat:

It is also worth bearing in mind that export volumes, which don’t take into account price and currency fluctuations, rose only 6.1% y-o-y in June, and thus that a significant part of the increase in the surplus comes not from increased output, but from the increased yen value of sales prices in other currencies.

6.1% is really nothing to sneeze at, but I agree with the use of the word “only” and I probably would have used it myself. The point here is very relevant: as exports make up a greater and greater part of Japan’s GDP, the value risk increases, especially when they may not be any more serious downward pressure on the yen (sure, we will have that last push down (all the way to 125?), but I’m looking at the next five years), especially if interest rates actually do rise next month, and double especially if they are risen twice before the end of 2007.

So, what is the hedge against this risk? You’ll have to read Mr Hugh’s post for that…

Retail flows having impact on yen rates; housewives to blame?

But you already knew about the first part of that headline, right? It’s been all around the news for a while now, with the Nikkei telling us that individuals are keen to sell yen even at 120 on May 22, and IHT/Bloomberg telling us that the yen’s retail outflows are putting the Bank of Japan in a “bind” on June 11.

Both of these are signs of an overheating; once the average investor is on to the trend, that usually means it about to change direction (according to bullish lines of thought). Yet, we’re aware that the ultra-low interest rates in Japan are helping feed the carry trade, so individuals might be protected for now. The danger is if the BOJ does make a slight rise and there is a panic - but not a trend reversal - that wipes out (or spooks) heaps of unsavvy individual investors.

That’s neither here nor there. What is here is an article published yesterday by the Financial Times entitled, “Yen absorbs ‘Japanese housewife effect’.” This is the blame twist we’ve been waiting for: the weak yen is due to housewives sitting around selling yen. Brilliant. How do we stop them? Here’s my favorite quote from the article:

The gnomes of Zurich were accused in their day of destabilizing markets. The housewives of Tokyo are apparently acting to stabilize them.

That’s from none other than Bank of Japan board member Kiyohiko Nishimura.

The article gives us a rough estimate that exposure from margin trading could currently be at 20,000 billion yen, but does not say how much of this is driven by housewives.

Given the amount of capital tied up in yen-selling, Derek Halpenny, an economist at the Bank of Tokyo-Mitsubishi UFJ, is of the opinion that Japanese authorities might be reluctant to intervene in the foreign exchange market in order to strengthen the yen given the potential financial consequences for the general population.

I wonder if a Cabinet member will go on record with this?

Yen/Dollar Swings: All About the Carry Trade?

Are the headlines making your head spin yet? Back on Tuesday (June 26), Finance Minister Koji Omi told reporters, “Foreign exchange markets should reflect Japan’s economic fundamentals…We will keep a watchful eye on foreign exchange rates…The weak yen symbolizes the shrinking presence of the Japanese economy. It is obviously bad news.”

It caught my eye, but I knew it wasn’t policy. Nonetheless, we saw these headlines start to pop up on June 27:

Yen Rises Most in 10 Weeks as Investors Scale Back Carry Trades (Bloomberg)
Yen Rises for a Third Day as Investors May Unwind Carry Trades (Bloomberg)
Yen climbs on risk aversion, carry trade unwinds (Reuters)
A Meltdown From The Yen-Carry Trade? (Forbes)
FOREX-Yen rises on risk aversion, carry trade worries (Reuters)

Then, a day later:

Yen Weakens on Speculation Investors Are Restoring Carry Trades (Bloomberg)
FOREX-Yen’s rise fizzles as risk-aversion eases (Reuters)
BOJ’s Inoue Sees `Huge Amount’ of Capital Flows Leaving Japan (Bloomberg)

The writers must be having a ball. Once they have software to write these articles automatically, the news firms will save a quite a bit of money.

Meanwhile, the human beings will continue to do analysis. On June 26, writing at Seeking Alpha, Jordan Kahn (author of the excellent In the Money blog) published a piece entitled “The Yen Carry Trade is Alive and Kicking.”

As Mr Kahn put it:

The Yen has actually slid to a 4 1/2-year low versus the dollar. This indicates that the Yen Carry trade is alive and well…At some point, the Yen is likely to rally, and concerns about the unwinding of this massive trade will resurface.

It’s a short piece, but to the point: The trend is still there and still very alive, despite the major media’s panic over a swing down to 122.20 and up to 123.35 over two days (and we have to wonder if they’re forgetting about those low 121s earlier in the month - better chance to sell yen on ‘discount’).

The carry trade still has legs.

Darryl Whitten on the BIS Annual Report

On Tuesday, we reported on the recent annual statement from the Bank of International Settlements, which called the yen’s current value ‘Anomalous’. Since then, there has been little commentary about the report in any media. Today, a piece entitled BIS Report Calls Recent Yen Depreciation ‘Anomalous’ from The Japan Investor’s Darryl Whitten appeared on Seeking Alpha.

It’s a short article, but good. Mr Whitten has been on the ground in Japan for a long time and knows what he’s talking about, and in this piece he offers a view of the risks surrounding a weak yen. Here’s a snippet:

The negatives for Japan from a weak yen include,

1. Rising raw material purchasing costs for companies.
2. Increased reliance on exports.
3. Problems attracting foreign capital (even though Japan is actively encouraging FDI).
4. Growing inflation pressures (from rising corporate service prices).
5. The prospect of a tsunami of domestic savings flowing overseas to chase higher yields, which already is a structural component of the so-called yen carry trade.

Get over there and read the rest of the article.

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