Land of the rising yen: Japan’s soaring currency is the ‘cheapest in the world’ says Kames

Japan’s currency has outperformed all major rivals this year in a trend that looks set to continue throughout 2018, but it remains the ‘cheapest in the world’ compared to peers, according to Kames Capital’s investment managers Sandra Holdsworth and Gareth Gettinby.
On a trade-weighted basis – which measures average exchange rates of home versus foreign currencies and each nation’s share in trade – the Japanese yen has been on an upward trajectory since the start of January.
From a level below 90 at the end of 2017, it recently went through 92, its highest level since May 2017. The move upwards mean the dollar/yen exchange rate has conversely fallen from ¥113 in January towards ¥105, while the euro/yen rate has weakened from ¥137 to below ¥130.
Nonetheless, Kames’ research flags the yen as the world’s cheapest currency on a purchasing power parity (PPP), behavioural equilibrium exchange rate (BEER), and fundamental equilibrium exchange rate (FEER) basis, with the Chinese Yuan rated as the most expensive.
“The analysis of the aggregate values of currencies on a PPP, BEER and FEER concludes that the yen is the world’s cheapest currency,” the managers said.
“In particular the FEER valuation shows that Japan’s external balance (i.e. its current account surplus) is particularly undervalued, and in the event of a rise in risk market volatility, currency markets tend to allocate more importance to this attribute.
“Current volatility, as measured by the VIX, is at more elevated levels than in 2017. The current risk is trade wars and therefore protectionism, following President Trump imposing new tariffs on steel and aluminium imports. If these tariffs are the catalyst for a broader trade war, we expect the yen to strengthen given the uncertainty.”
Even without such an event coming to fruition, triple wins for the currency in the shape of Japan’s positive economic fundamentals, attractive valuations, and supportive technical data point to another robust nine months for the yen, the managers said.
They highlighted Japan’s rising inflation and record corporate profits as key factors which should continue to give the currency impetus this year, with companies able to boost pay during the upcoming spring wage negotiations thanks to the returns they are making.
Central bank plans to tighten the money taps also provides support. Bank of Japan governor Haruhiko Kuroda recently hinted at exiting stimulus for the first time since quantitative easing began in 2013.
He has already been ‘stealth’ tapering – keeping bond purchases steady but effectively undershooting quantitative easing targets using the ‘Yield Curve Control’ policy.
“We have observed a tendency for sharp appreciation pressures on currencies when central banks embark on policy normalisation, as witnessed last year in the case of the euro,”
On a technical basis, the yen also appears particularly attractive, the managers added, with recent moves by Japanese investors to repatriate their investments overseas helping drive the yen higher.
“It is expected this flow will continue into the Japanese financial year-end. “As such, we believe the currency will continue to strengthen throughout 2018.
“One could draw similarities between the drivers of the euro in 2017 – when it rallied against the dollar after the French election, driven by strong economic data, the unwinding of short positions and a change in rhetoric of the ECB towards normalisation – and the current performance of the yen.”