Japan’s balance of payments is worsening, but this alone is not enough to change our bullish stance on the yen.
I n the twelve months to August, the Japanese current account surplus remained close to a 15-year low, net portfolio investments turned negative for the first time since May 2011 and net foreign direct investment outflows were near a record high. However, this is not necessarily negative for the yen against the dollar.
Japan’s basic balance (current account plus long term capital flows) deficit of 1.6% of GDP is only half the size of the U.S. In addition, net portfolio flows to Japan should improve. Japanese investors will be reluctant to recycle their excess savings into overseas assets as interest rate differentials between the U.S. and Japan are negligible.
Historically, Japanese investors have required a minimum 400bps of additional yield as compensation for assuming currency risk. With the Fed committed to holding rates near zero until mid-2015, interest rate differentials will remain bearish for USD/JPY for quite some time. Also, the BoJ will be less aggressive than the Fed and ECB in expanding its balance sheet, which will push USD/JPY and EUR/JPY lower. But most importantly, the yen will provide portfolio protection during “risk off” periods.
Bottom line: Maintain long positions in the Japanese yen.