RISING YEN HURTS JAPANESE MARKET -- RISING YEN MAY ALSO BE ADDING TO GLOBAL DEFLATION PRESSURE
RISING YEN PUSHES NIKKEI TO NEW LOW... A rising Japanese yen is normally bad for Japanese stocks. Chart 1 demonstrate their inverse relationship. It shows the the Nikkei 225 (orange line) falling below 9000 for the first time in more than year which makes it the weakest of the world's major markets. The green line on top of Chart 1 shows the Japanese yen having exceeded its late 2009 peak. The most obvious reason for that negative correlation is that a rising yen makes Japanese exports more expensive, and the Japanese economy is heavily dependent on exports. In this message, I'd like to propose a second possible reason why a rising yen is hurting Japanese stocks and, even possibly, increasing global deflationary problems that are becoming a more important issue. It may also shed some light on recent warnings about the U.S. slipping into a deflationary spiral that has plagued Japan for the last two decades. Here's my basic premise. Japan is the world's third largest economy (having just been passed by China). Since 1998, deflation pressures that started in Japan started to infect global economies and paved the way for growing deflationary pressures a decade later. The rising yen contributes to that problem since it makes Japanese deflation even worse (by pushing domestic prices lower) and, by extension, increases global deflation problems.
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Chart 1
YEN SURGES AGAINST GLOBAL CURRENCIES ... I'm not going to speculate here on "why" the yen is rising against the world's major currencies (although it may have something to do with unwinding the "yen carry trade" that fueled the global boom prior to 2007). My main point is that the yen "is" rising against all of the world's major currencies, and in a big way. The next three charts show the yen rising strongly against the U.S. Dollar (Chart 2), the Euro (Chart 3), and the Aussie Dollar (Chart 4). There are two time periods on all three charts that are most important. The first is the surge in the yen from 1998 to 2000. That 1998 yen surge followed the Asian currency crisis that started in 1997 and lasted well into 1998. My 2004 book on Intermarket Analysis identified 1998 as the year when global deflationary pressures started coming from Asia -- and Japan in particular. I've written before about the deflation threat that started in 1998. My June 24 Market Message (Link Between Bonds and Stocks Changed in 1998) includes the statement: "...The bond/stock relationship changed during 1998 as a result of the Asian currency crisis and the onset of global deflation". [See also my July 1 message entitled "I've Been Using the Deflation Model for the Last Decade"]. Notice the sharp upturn in the yen that lasted from 1998 to 2000 (orange boxes) which coincided with that initial deflation threat (the upturn was more pronounced against foreign currencies). A second yen surge started during 2007 against the world's major currencies (see circles) right around the time that global deflationary pressures became even more pronounced. The yen has since become the world's strongest currency. In my view, the rising yen has made the deflation problem in Japan even worse and may be a driving force pushing global interest rates to near record lows.
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Chart 2
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Chart 3
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Chart 4
LINK BETWEEN JAPAN AND US RATES ... My 2004 book also wrote about the close correlation between the Japanese stock market and U.S. interest rates. The reason for doing so was to make the case that Japanese deflation was helping pull global interest rates lower (even though the deflation threat wasn't yet evident in the U.S. and elsewhere). Chart 5 shows the remarkably close correlation between the Nikkei (orange line) and 10-Year U.S. T-Notes (green line) over the last 15 years. Both have recently fallen to 52-week lows. My premise then and now is that the Japanese market, which is the world's weakest, is one of the factors driving global rates lower owing to increasing deflation pressures. Part of the reason may be the rising yen. Chart 6 compares the yen (versus the dollar) directly to U.S. bond yields over the last decade. The chart shows a generally inverse relationship between the two. Surges in the yen in 2002 and again starting in 2007 coincided with falling bond yields. Chart 6 seems to imply that the rising yen is part of the global deflationary problem. But it also suggests another vehicle to help ride out the deflationary storm.
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Chart 5
