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Just what's the matter with the yen?
As Tim Lee pointed out in yesterday's FT, everything about the currency markets at the moment looks out of whack, to put it bluntly.
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"A simple purchasing power parity exercise suggests that the New Zealand dollar is 20% to 25% overvalued against the US dollar, while the Turkish lira is about 65% overvalued. The yen meanwhile is roughly 30% undervalued."
That's not to mention the fact that the Japanese economy has experienced continuous growth for the past five years. And even though deflation has proved a persistent enemy, data yesterday found that Japanese corporate service prices rose at the fastest pace in more than nine years in May, rising 1.4% on the previous year more on that later.
Yet the Japanese currency is at record lows against almost anything you care to mention. So what's going on and how long will it last?
Tim Lee, founder of financial consultancy Pi Economics, points out in the FT that the main thing driving currency markets at the moment is interest rates, rather than any consideration of the economic fundamentals (or fair value' of each currency).
So you have traders borrowing in low interest rate currencies like the yen to invest in countries with high rates the carry trade, as it's called. Lee says this is a key symptom of the "global credit bubble" we're now in. He puts the size of the trade at "at least $1,500bn".
He argues that this has spilled over into "credit, equities and real estate markets". But the trade can't carry on for ever. "Ultimately there must be a sharp convergence of exchange rates with fair values, inflicting heavy losses on carry trades."
What could drive this return to fair value? Lee doesn't go into that in detail, but an obvious candidate is Japanese inflation. As mentioned in the introduction, corporate services costs are rising fast in the country. Mayumi Otsuma and Harumi Ichikura report on Bloomberg: "Faster growth in the costs companies pay for services such as transportation and rent may prompt them to raise prices, sparking inflation."
Meanwhile, Japanese central bankers have been starting to talk up the yen. David Fuller of Fullermoney reckons "we can expect the BoJ's next interest rate hike in August or September the long-delayed but inevitable process of normalising rates in Japan will commence."
Mr Fuller reckons that higher rates could actually be good for Japanese stocks, confirming "beyond any lingering doubt that Japan Inc really is back in business."
Eventually, whether it's down to rising rates or some other cause, the yen will strengthen. And that's when we'll find out just how much of an impact the carry trade has had on the global economy.
We can't be sure exactly what will happen, as it's impossible to tell where carry trade money has actually ended up. But if traders are forced to evacuate positions and the yen appreciates rapidly, we can certainly expect some serious turmoil throughout the markets. As far as we're concerned, one of the best places to be invested (apart from in cash and gold, of course) at that point would be Japan as a UK investor, you'd benefit from the surging yen, even if equity prices did fall in tandem with other global markets.
There are plenty of other reasons to be upbeat on Japan. In fact, MoneyWeek regular James Ferguson was out there just a couple of weeks ago and tells me that the investment story on the country's property market is even better than he'd thought and as regular readers will know, James is pretty bullish when it comes to Japanese property. He wrote up his detailed views for readers of his investment service Model Investor last week you can find out more about the service here: Model Investor.
Turning to the wider stock markets
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In London, the FTSE 100 closed 29 points lower, at 6,559, yesterday. BAE Systems was by far the biggest blue-chip faller following news of an investigation into its Saudi Arabia operations by the US authorities. For a full makret report, see: London market close.
Elsewhere in Europe, the Paris CAC-40 ended the day 9 points weaker, at 5,953, whilst the DAX-30 was 70 points lower, at 7,860, in Frankfurt.
On Wall Street, the Dow Jones average was 14 points lower at 13,337, the tech-heavy Nasdaq was 2 points lower at 2,574, and the S&P 500 closed down 2 points at 1,492.
In Asia, the Nikkei fell for a fourth consecutive session, sliding 216 points to close at 17,849.
Crude oil was little-changed at $67.78 this morning, whilst Brent spot had risen to $71.31 a barrel.
Spot gold plunged over $10 in New York yesterday and dipped to a three-month low of $638.90 in Asia trading, but was last trading at $640.50. (For more on the latest developments in the gold market, see our London gold market report. Meanwhile, silver fell to its lowest level since January today - $12.11 - and was last trading at $12.16.
In the currency markets, the pound had fallen to $1.9946 against the dollar this morning, having climbed above the $2 mark yesterday. The pound was at 1.487 and the dollar was at 0.7442 against the euro. And the dollar had risen to 122.57 against the Japanese yen.
And in London this morning, mortgage lender Northern Rock announced that full-year profits would probably miss analysts' estimates as higher rates dampen demand for home loans. Northern Rock's shares had tumbled by as much as 11% to 844p in early trading, whilst peers HBOs, Bradford and Bingley and Alliance and Leicester were also lower.
And our two recommended articles for today...
What next for Wall Street?
- Opinions vary as to whether US equities are currently in a long bull market, a bear market or an extended correction, but a crucial way of looking at the situation is to consider the relationship between corporate profits and credit. To find out why 'toxic debt' is threatening US equities, click here: What next for Wall Street?
Bird flu, bioterrorism - and other developments in the vaccines sector
- The development of a new wave of mass-produced immunisation products targeting a wider demographic, along with increased government spending to protect us from bird flu and bio-terrorism, mean that there are crucial changes taking place in the vaccines market. To find out how the major players are faring, click here: Bird flu, bioterrorism - and other developments in the vaccines sector
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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