The Bank of Japan ended its negative interest rate policy in March this year, keeping interest rates at 0%-0.1%, the first rate hike since 2007, as shown in the chart below.
However, the yen did not get a boost against the US dollar, but fell again and again, falling to the 160 level in the early part of April 29, 2024, and although it returned to below 160 with the intervention of the Bank of Japan shortly after, it was still weak and never broke above 155, as shown in the chart below.
The high correlation between the Japanese yen and the negative interest rate since February 2016 shows that the yen has been falling against the US dollar since February 2022 (the higher the value, the lower the yen will be against the US dollar).
What are the root causes of the yen's depreciation?
The widening of spreads is the most intuitive explanation for this movement.
The Fed began its rate hike cycle in March 2022 and is now at the high end of the US dollar interest rate cycle as the market expects the Fed to start cutting interest rates in the second half of the year.
However, judging by the recent decent US employment data and the somewhat stubborn CPI, the market seems to realize that the expectations for the Fed to embark on a rate cut cycle are a bit overly optimistic.
In other words, it is possible that the US dollar interest rate will remain high for an extended period of time. At the same time, in order to stabilize exchange rate expectations, the Bank of Japan said that it will remain accommodative in monetary policy, which means that it may not raise interest rates further.
This means that the interest rate differential between the US dollar and the yen will be at a high level for a period of time, which is undoubtedly a favorable time for speculative funds to short the yen - selling the yen, buying high-interest currencies, and then buying back the yen to close the position, which can not only earn interest differentials, but also earn another exchange rate difference when the yen depreciates further, which is a profitable business.
As you can see in the chart below, the spread between the U.S. 10-year Treasury yield and the JPY 10-year Treasury yield has risen sharply since 2022 and has remained high above 300 basis points since the end of 2022, and even exceeded 400 basis points in October 2023 when the Fed's rate hike cycle may peak at its peak.
However, as can be seen from the chart above, interest rate differentials actually fell at the end of 2023, and although they have recently recovered slightly due to speculation that the Fed may delay the rate cut cycle, they have not yet returned to the level of late 2023.
Finet believes that the rampant speculation should be the main reason - betting that the Bank of Japan will not intervene in the currency market on a large scale and unexpectedly, and on the other hand, Japan's economic fundamentals do not seem to have improved significantly, prompting funds to quickly flee Japanese assets and move to gold (safe-haven), the dollar (higher interest rates) and emerging markets (such as China).
Japan's just-released economic data shows that in the fourth quarter of 2023 (September-December 2023), its real GDP (calculated in terms of total social expenditure) was 142.64 trillion yen, a year-on-year increase of 1.20%, the lowest increase in the four quarters of 2023, as shown in the chart below.
From the perspective of sub-sectors, Finet noted that in the fourth quarter of 2023, household consumption expenditure, the largest component of Japan's GDP, actually fell by 0.52% year-on-year, while government spending only increased by 0.1%, and the biggest driver of its real GDP growth should be exports, which increased by 3.52% year-on-year.
At the height of the pandemic in 2020, Japan's overall GDP declined despite government spending growth, while in 2023, its overall GDP growth of 1.92% was still higher than the previous year's 0.96% due to the growth of exports, despite the slowdown in household consumption expenditure and government spending.
The growth of household consumption expenditure in Japan is weak, but the depreciation of the yen has encouraged a large number of tourists to travel and shop in Japan, which will help boost domestic demand, and at the same time, the depreciation of the yen will also benefit the export of Japanese companies, which is the benefit of the pressure on the yen exchange rate.
According to data from the Ministry of Finance, the value of Japan's exports increased by 7.32% year-on-year to 9.47 trillion yen in March this year (the latest wave of yen decline began in early March), while the value of imports fell 5.13% year-on-year to 9.08 trillion yen, and generated a trade surplus of 387.01 billion yen.
However, the continued depreciation of the yen exchange rate also has its downside. Japan is a relatively resource-poor country, and many resources, minerals, and consumer goods need to be imported.
In 2023, for example, Japan's trading partners with the highest net import value are Australia and the Middle East (especially the Arab and United Arab Emirates), as they need to import minerals from Australia to process them into finished products for export, such as importing large quantities of iron ore, and processing them into steel to support their automobile manufacturing and export industries – automobiles are Japan's most valuable exports, and they also need to import fuel from the Middle East to support their domestic consumption.
As a result, a weaker yen will lead to higher domestic production and consumer prices – imports will be inflated by the depreciation of the yen, for example, steel factories in Japan will have to pay higher yen prices for imported minerals, resulting in higher production costs – the cost of auto manufacturing will rise, and if the price cannot be passed on to the export price, the producers will absorb the losses, and similarly, consumers will have to pay higher yen prices for imported gasoline, which will suppress their willingness to spend, which is not something that the authorities are happy to see.
In addition, according to the IMF, Japan's debt-to-GDP ratio continues to climb, reaching 261.3% in 2022, while according to commodity.com data, the ratio is still as high as 241.64% as of April 16, 2024, that is, the government's debt is much larger than its annual revenue, which will increase the cost of government borrowing and fiscal pressure.
This is the main reason why the Bank of Japan quickly intervened when the yen fell to 160.
Everyone may be concerned, what impact does the depreciation of the yen have on Warren Buffett, the "stock god" who has vigorously entered the Japanese capital market?
The depreciation of the yen and the transaction of Warren Buffett responded
As early as August 2020, Warren Buffett bought five conglomerates in Japan, namely Mitsubishi Corporation (8058. TYO), Mitsui (8031. TYO), Itochu Corporation (8001. TYO), Marubeni Corporation (8002. TYO) and Sumitomo Corporation (8053.TYO), and continue to increase their holdings.
These five companies are not ordinary, they have a long history and a global reach. Of particular interest is the fact that these companies share a common characteristic: mineral resources constitute their main source of revenue. In addition, these companies have a diverse business that extends to all aspects of consumer life in Japan and abroad.
As mentioned above, Japan has obvious deficiencies in mineral resources. Despite this, as an important force in the world's industry, Japan's industrial production is highly dependent on mineral resources, such as iron ore, copper, lead, nickel, etc. In order to cope with this challenge, Japan's Ministry of Economy, Trade and Industry (METI) has been actively guiding large domestic enterprises to invest in mineral resources as early as the last century. It is worth mentioning that the five major groups in which Buffett has invested are large in the field of mineral investment, so they can take full advantage of Japan's market demand and economic development opportunities. In addition, since the mineral resources of these enterprises are mainly concentrated abroad, they are relatively less affected by the depreciation of the yen in the operation and management of mineral resources.
As shown in the chart below, these five major groups have risen by more than 70% since the Japanese stock market surge in 2022, with the share prices of Mitsubishi Corporation and Mitsui & Co. more than doubling.
Since the surge in the Japanese stock market in 2022, the five groups have risen by more than 70%. In particular, the share prices of Mitsubishi Corporation and Mitsui & Co. have more than doubled. And this year, the five groups continued to maintain strong double-digit growth, demonstrating their strong potential for capital appreciation.
What is even more interesting is that the recent JPY bond issuance financing strategy adopted by Warren Buffett covers the general needs of corporate operations. The transaction is essentially an arbitrage exercise, which involves borrowing yen at a lower cost, then converting the funds into other high-interest currencies and investing them in high-interest assets. When the bond matures, the funds will be exchanged back to Japanese yen to complete the repayment of principal and interest.
According to the documents submitted by Berkshire (BRK.B.US) in the US Securities and Exchange Commission, the total principal amount of this batch of bonds is 283.3 billion yen, or about 1.819 billion US dollars, of which the largest principal is the three-year 169 billion yen senior notes with an annual interest rate of 0.974%, and Finet estimates that its total annual interest rate is about 3.471 billion yen, or about 22.29 million US dollars, based on the data of this batch of bonds, with an average annual interest rate of only 1.225% For Berkshire's (BRK.A.US) hundreds of billions of dollars in cash holdings, such interest expenses are not a problem at all, the key is that Berkshire can use the borrowed funds to earn much higher returns than this cost, and the risk-free US Treasury yields alone are much higher than this rate, according to Ycharts, the current US 1-year Treasury bond yield is 5.21% , meaning that Berkshire will earn at least 399 basis points in the spread, not counting the gains from a further decline in the yen's exchange rate.
This is exactly the investment logic of the "stock god".
Therefore, the wisest investment strategy is not to maximize the risk and return when the wind is high, but to gain insight into the future trend of the macro economy in advance when the wind is calm to ensure stable returns without risk. This concept hopes to help investors who are at the crossroads of the capital market and are confused.
Author: Mao Ting