A Bold Outlier Call on the Yen

Key Takeaways

In our recent episode of Behind the Markets, we spoke with Ken Taheny, Head of Trading/Co-Portfolio Manager at Four Ships Asset Management, who shared his view on the short-term and long-term projections for Japan and the yen.

The conversation kicked off with the recent turmoil in Japan’s stock market following the Bank of Japan’s rate hikes and the resulting currency volatility as the yen appreciated from its highs of more than 162 yen per dollar to 147 Friday and as low as 142 on Monday, August 5, 2024.¹ This sharp appreciation caused some major unwinds and seemed like margin calls from levered market participants. The Nikkei fell more than 10% on Monday, its largest one-day drop since October 1987.² 

Focusing on Dividend and Value Stocks and Financials: Much like the U.S., Japan had been led by technology and so-called “innovation stocks” in the semiconductor area. But Ken particularly likes some short-run opportunities in financials and value stocks even more than chips stocks, which are most susceptible to the yen’s volatility. Banks, in particular, could be benefiting from the rate hikes from the Bank of Japan, even though they had some of the highest volatility last week.³ 

Long-Term Outlook on the Yen: A significant part of our discussion was Ken’s long-term forecast for the yen, which he believes could weaken significantly against the dollar, potentially reaching as low as 250 yen to the dollar. This projection is based on several factors, most notably a geopolitical shift where manufacturing supply chains are moving out of China and toward Japan, Mexico and the southern U.S.

Ken believes high-value manufacturing in chips, technology and robots will migrate to Japan and a weak yen is in both the U.S. and Japan’s interest to foster based on the geopolitical shifts. Ken believes the Japanese consumer and voter could live with a weaker currency, even when all the vibes suggest tourists flock to Japan based on how far currencies can go against the yen. Ken still believes further weakening is likely once this short-run volatility subsides and the overall economic benefits will outweigh the inflation and import price risks.

Higher Inflation in the U.S. Leads to Higher Rates: Part of Ken’s outlook for the yen is a longer-term structurally higher inflation call for the U.S. that keeps rate differentials higher than many expect for longer than they expect.

Ken sees potential for only two more rate hikes in Japan, and while the Fed might be lowering rates soon with inflation trending down, he sees that ultimately having to be reversed in the future, which can bring back the yen carry trades.

Already since our interview, a Bank of Japan deputy governor commented in a speech that it would likely refrain from further hikes if this current volatility bout continues.⁴ 

Ken’s call on the yen for such weakening is aggressive—and this is not a WisdomTree baseline forecast to any extent.

I thought the discussion on Behind the Markets was illustrative, though, that one should question how much conviction they have in any worldview on these currencies.

I had emphasized the Warren Buffett strategic worldview on exchange rates when he started buying Japan. Buffett wrote in a 2023 letter: “Neither Greg [Abel] nor I believe we can forecast market prices of major currencies. We also don’t believe we can hire anyone with this ability.”⁵ This oft-quoted statement rings true as the yen rallied more than 8% against the dollar in July alone after sliding almost 12% since the beginning of the year.

I believe that hedging currency makes strategic sense to lower volatility, and one can also earn carry on top of the local market returns. These carry trade unwinds—typically from levered hedge funds—are what created much market turmoil and panic in the last few weeks.

However, when one buys a currency-hedged ETF, there is no leverage involved; it just neutralizes the yen exchange rate risk and adds the interest rate differential between the U.S. and Japan. Right now, that level is 5%, and the 5% might come down to 3%–4%.⁶ But I don’t think it is going back to zero as it was after the financial crisis.

You can listen to our full conversation here or below.

¹ Source: Bloomberg, with data as of 8/5/24.

² Source: Laura He et al., “Japanese stocks rebound from worst crash since 1987 while global markets are mixed,” CNN Business, 8/6/24.

³ “Last week” refers to the week ending August 2, 2024, and starting July 29, 2024.

⁴ Source: “Bank of Japan won’t raise rates when markets unstable, deputy governor says,” Reuters, 8/6/24.

⁵ Source: Berkshire Hathaway 2023 Annual Report.

⁶ Source: Bloomberg, with data based on the difference between short-term interest rates, typically one-month, between the United States and Japan. The calculation is the U.S. short-term rate minus Japan short-term rate. As of August 5, 2024, the difference was about 5%. If the U.S. Federal Reserve lowers the Fed Funds policy rate, this difference may become smaller.