Japanese Yen Weakens Following Trade Balance Data

During the past weeks, as euro fears have caused safe haven seekers to buy the yen, that currency has remained firm. The move was most pronounced in the EURJPY. In April 2011 the pair traded as high as 1.23 before plunging to a low of 97 this month.

The yen strength, though, contains the seeds of its destruction. The 25% appreciation in the yen value compared to the euro, makes Japanese exports to Europe very expensive. Combine this with the soft euro economies, and the Japanese exports have taken a tumble. For the first time in 31 years, the Japanese have reported a trade deficit.

The disruption caused by the earthquake and subsequent tsunami is another reason for the trade deficit. Not only did the devastation cause havoc with the manufacturing plants, the electric supply was reduced because of the damaged nuclear plants. About 25% of atomic power, permanently, lost is being replaced with electricity from imported coal, oil and LNG. This energy cost also hurts the trade balance.

A combination of high energy costs and supply disruptions combined with the strong yen has caused Japanese companies to move production from Japan. Nissan (NSANY.PK), for example move some production to Thailand, where they have access to cheaper labor as well as energy. Honda (HMC) has switched production of the Acura to Ohio, and their less expensive models to Mexico. All models can now be produced in North America.

The trade balance report came at a time when the COT report revealed futures speculators had accumulated long yen positions of over 59K contracts. Even the small specs had flipped their position to the long side. With this set up, we should not be surprised with the yen losing to the USD Wednesday. The USD is now trading above the 78 handle, a level which seemed to attract some yen buying when the Bank of Japan intervened in late October, as a seller.

Looking forward, we think there are some major problems with the Japanese economy, and question if the safe have status is deserved. In the past, the Japanese were thrifty savers, but now as the population is aging they are spending these savings.

The Japanese government, since the economic bust in the early nineties has engaged in heavy deficit spending. Now, the total government debt is over 200% of the GDP, among this highest in the world. With 2 year paper yielding .13% and ten year notes 1.01%, the big debt is manageable, but should the fear of government debt spread, higher yields would sink the Japanese government. A much weaker yen would be another result.

We prefer to buy the USD and sell the yen should this pair sell off toward the 77 handle. We doubt the market is going to run very far at the moment so you can afford to be patient. As always, manage your money.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.