A Yen Above 100? Bet Your Bottom Dollar It Will Be Fine

(Bloomberg Gadfly) -- Imagine a world in which the Japanese currency strengthens past the psychologically important level of 100 yen per dollar. It wouldn't be so bad.

With Prime Minister Shinzo Abe's approval rating edging toward July's low, traders are doing a U-turn on their yen bets. Hedge funds are now in favor of a stronger Japanese currency for the first time since last spring, while options traders have $160 billion in put contracts that the yen will rise to 100 or above, $30 billion more than three months ago.

Even perpetual bears are losing patience.

Every year, major companies in Japan negotiate with workers' unions on pay rises. This year, the increase in base was 0.77 percent, data released by the Japanese Trade Union Confederation show.

While that's the biggest gain since Abenomics began in late 2012, one can't help questioning if it's enough to lift inflation from January's 0.9 percent to the targeted 2 percent. Bear in mind that Bank of Japan Governor Haruhiko Kuroda has already floated the idea of starting to exit monetary stimulus around the fiscal year beginning April 2019.

At some point, the BOJ will need to worry about its monetary easing creating instability in Japan's banking system. With net interest margins at less than 1 percent, regional lenders aren't keen to take risks, while the bigger players have turned their attention overseas. As a result, regional banks' capital adequacy ratios have been deteriorating.

The prospect Abe may not survive the September election is rapidly changing the landscape. If he remains in power, Kuroda may feel compelled -- since Abe gave him the job -- to stay on course with massive monetary expansion, Abenomics' first arrow. Yet Kuroda knows well the detrimental effects of keeping interest rates too low for too long.

Japan is highly cyclical. If the global economy is broadly rebounding -- assuming U.S. President Donald Trump doesn't destroy things with his tariffs -- its exporters can still grow even with a stronger currency. Case in point: The nation's exports rose in February for a 15th consecutive month as the yen strengthened 2.6 percent.

And the yen's strength really only reflects a weak dollar. Over the past year, the yen has fallen 7.9 percent against the euro and has hardly risen against South Korea's won and Taiwan's dollar. According to Societe Generale SA, in trade-weighted terms, the Japanese currency has appreciated by just 3 percent since the start of 2017.

As the world's largest central banks continue on a tightening bias, will the BOJ be the lone dove? Perhaps, but that doesn't mean yen bulls have anything to fear.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

©2018 Bloomberg L.P.

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