120 Yen to the Dollar: Implications of the Dollar’s Appreciation and the Yen’s Depreciation
Stock price indexes in major countries are rising at a slightly faster pace, but generally in line with my outlook in my previous column, “Japanese Stocks in Major Bottom Zone Even If Ukraine Is Prolonged.” The two main points I made in that column are as follows:
(1) On a closing price basis, the Nikkei 225 Stock Average was at 24,717 yen on March 9 and the New York Dow Jones Industrial Average was at its lowest, 32,632 on the previous day.
(2) Stock prices will return to a long-term uptrend after the current bottoming out.
Why Did Stock Prices Bottom Out in Early March?
For more information on the background to the stock market’s renewed long-term uptrend, please refer to the previous column, but here are some of the main issues we discussed:
・The theory that energy prices will continue to skyrocket and that the global economy will fall into stagflation (simultaneous inflation and recession) is too pessimistic.
・The United States bond market indicates that the economy will slow down (even at a positive growth rate) but not go into recession (negative growth rate) for at least the next year.
・The firmness of Japanese and American small- and mid-cap stocks (excluding Tokyo Stock Exchange High-growth and Emerging Stocks) also suggests that investors are beginning to bet on long-term earnings growth potential rather than worrying about earnings risk of small- and mid-cap companies.
・The United States Federal Reserve will be flexible in its response and monitoring data, including the negative economic impact of the energy price hikes to date.
・As for China’s adventurous behavior in Taiwan and the Spratly Islands, which could be bad news for the market, the fact that Russia has achieved less military success than initially expected in Ukraine, while its economy is being driven into a corner by severe sanctions from the West and other countries, could serve as an object lesson for China.
・Revised profit forecasts by analysts in Japan and the United States are compiled in real time, and the analyst consensus (average of analyst profit forecasts) indicates that earnings per share are expected to increase by around 30% year-on-year in both Japan and the United States.
To add to these, first, with regard to energy prices, the price of West Texas Intermediate crude oil futures, the international benchmark for crude oil, has remained calm, albeit at a high level, in the low $110s per barrel.
In addition, looking at the difference between long- and short-term interest rates in the United States bond market, some people seem to be making a big deal because the yields on the 5-year and 10-year Treasury bonds have reversed, but the difference between the 2-year and 10-year Treasuries has not yet reversed. And even if it were to reverse in the future and signal a recession in the United States economy or a decline in stock prices, as it has in the past, the economic downturn and downward trend in stock prices would not occur until 2023.
Japanese and American small and medium-sized stocks have firmed. In Japan, however, it is assumed that a wide range of large-cap shares in the real market or index futures were purchased by foreign investors last week (March 21-25) due to a recovery from the general view, and this pushed up the stock prices of the First Section of the Tokyo Stock Exchange through arbitrage trading.
However, if positive views spread on Japanese stocks, it would strengthen buying attitudes toward individual stocks and allow funds to flow into small-capitalized stocks that are expected to generate profit growth.
Acceleration of Interest Rate Hikes Does Not Shake the Recovery Trend of the United States Economy
Meanwhile, the Fed ended quantitative easing and began raising interest rates. This was followed by reports of statements by Federal Reserve Board Member Christopher Waller and St. Louis Federal Reserve President James Bullard on March 18, and Fed Chairman Jerome Powell on March 21.
Although each of them indicated that they would increase interest rates in the future, their main message was that the recovery trend of the United States economy would not waver even if interest rates were to accelerate. This seemed to have increased the stock market’s confidence in the economic outlook.
In addition, earnings per share based on the average analyst estimates are expected to increase by 33.9% in Japan (the entire first section of the Tokyo Stock Exchange) for the next 12 months (equivalent to the fiscal year ending March 31, 2023) as of March 25. The United States market is also expected to see a 28.5% rise in S&P 500 Index stocks.
While it is unclear what China will do in light of the situation in Ukraine, we believe that the situation is in line with our assumptions regarding each of the factors we pointed out in the previous section.
Although I have not discussed the yen market much in this column, many of you may remember my outlook for the dollar-yen market, which I advocated at the beginning of the year.
The outlook was that the yen would weaken against the dollar to around 100 yen per dollar as global stock prices would fall in the first half of the year and risk aversion would intensify, but that the dollar would subsequently strengthen against the yen as stock prices recovered, reaching around 115 yen per dollar.
In practice, however, the yen appreciated only to the ¥113 level. What’s more, the yen has recently entered the ¥122 level. The outlook for this was completely wrong.
Even If $1 to ¥130 Is Too Much, the Yen Will Continue To Depreciate
Regarding the outlook for the future, the conclusion is that the dollar will appreciate slightly against the yen from the current level, or the yen will remain at the current level for a long time, but we do not expect a significant depreciation of the yen to the dollar, such as to 130 yen to the dollar.
First, regarding the point that we do not expect the yen to weaken significantly, various analyses suggest that the dollar has already appreciated too much against the yen.
Purchasing power parity is an estimate of the dollar-yen exchange rate at which price levels in Japan and the United States are generally similar. Since the actual yen exchange rate has sometimes deviated from purchasing power parity by more than 20%, purchasing power parity is not very useful in making near-term market forecasts. However, in the past, the yen exchange rate has remained within a deviation of plus or minus 20% for many periods. It would be possible to discuss the long-term level.
Looking at the actual deviation of the dollar-yen exchange rate from this purchasing power parity, the monthly average deviation in February of this year was as much as 32.0% in the direction of yen depreciation. In fact, the previous record divergence was 28.4% in October 1982, and other than February of this year, there has never been a divergence of more than 30% in the direction of yen depreciation.
In other words, comparative consideration of United States and Japanese prices indicates that the yen has already weakened to record levels against the dollar (thus, there is limited room for further depreciation of the yen).
On the other hand, the dollar’s nominal effective rate (a weighted average of the dollar-yen exchange rate against various currencies, indicating the overall strength or weakness of the dollar) can be used as a reference when considering the current market price from the dollar’s side. In recent years, there has been a conspicuous “risk-averse appreciation of the dollar” that has taken the place of the risk-averse appreciation of the yen.
The reason for this is that, looking at the overall global economy and securities and financial markets, investments in the United States are still the most secure in relative terms. Therefore, if some risk emerges somewhere in the world, there will be a noticeable movement to withdraw funds from countries that are considered dangerous and invest them in the United States.
In the past, the last time the dollar appreciated considerably in such a sense was during the vortex of the March 2020 COVID-19 disaster. Although the current nominal effective rate of the dollar is not quite at the level it was then, the dollar’s overall level is close to its highest ever, except during the period of greatest concern about the COVID-19 pandemic, due to the dollar’s strong appreciation trend since mid-2021.
In other words, the dollar has already been bought to a very high level, and if the yen is to weaken further, there is still more room to do so against other currencies, such as the euro and the Australian dollar, than against the United States dollar.
Concerns that the Japan Sell-Off in the Currency Market Will Extend to Japanese Equities as Well
Based on the above, we expect that even if the yen weakens against the dollar, it is unlikely to be significant. On the other hand, we also anticipate that there is a strong possibility that the yen will still appreciate against the dollar a little, or that the yen will continue at its current level.
What I feel is the most talked-about issue among global investors at the moment is the sell Japan aspect due to the difference in monetary policy between Japan and other countries. The difference in monetary policy is directly attributable to the fact that the Bank of Japan has been stuck while major Western countries have been reducing their monetary easing, but investors around the world seem to see Japan as a country where the Bank of Japan is unable to change its monetary policy, which is rather pathetic.
The background of this difference between Japan and the United States was discussed in a column dated Feb. 14. It can be summarized as follows.
In the United States, as in the past, companies will not hesitate to pass on cost increases through selling prices to defend corporate profits. As a result, households tend to buy now while prices are likely to continue to rise; even if they are short of cash on hand, they believe that wages are rising; even if they purchase with credit cards or loans, they believe they will easily be able to repay the loans with their future income growth.
In Japan, on the other hand, companies are concerned that raising prices will result in lower sales, and try to avoid raising prices as much as possible through corporate efforts. As a result, corporate profits are squeezed. This corporate effort includes holding down employee wages. And since households are unlikely to see large wage increases, they are likely to become defensive, saying they will save money and cut back a lot on purchases when companies raise prices significantly.
Turning back to the future of Japanese stock prices, we believe they will follow an upward trend in line with the global stock market rally. However, we are concerned that the Japan sell-off in the foreign exchange market will spread to the stock market, and the speed of the Japanese stock market rally may one day be curtailed.
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