Exploring Causes Behind the Yen's Historic Low and Capitalizing on Investment Strategies Amidst Currency Volatility

On April 24th, local time, the Japanese yen hit a 34-year record low, with the USD/JPY exchange rate breaching the 155 mark. The sustained weakening of the yen has both surprised and surpassed market forecasts in terms of duration and magnitude. What are the core reasons driving this phenomenon? What is the state of Japan's economy in light of these events, and which investment prospects may emerge from these unfolding circumstances? This piece will systematically explore each of these topics.

In both horizontal comparison with other economies and through an overarching review of Japan's economic conditions, the nation's economy currently displays a clear downturn. The persistent weakness of the Japanese yen has garnered worldwide attention, and while the Japanese government has indicated that "it will not exclude any policy measures to address the issue," the current situation suggests that even if official intervention is undertaken, it may not fundamentally reverse the trend, leaving the outlook for the yen's value still bleak. The specific reasons underpinning this situation include the following points:

Despite the Bank of Japan ending its negative interest rate policy last month, the interest rate post-hike remains effectively close to zero. In contrast, market expectations for rate cuts in the United States during the year have weakened, thereby maintaining a substantial interest rate differential between the two countries. Typically, higher interest rate differentials lead to capital flows from low-interest-rate nations to those with higher rates in search of greater returns. In this scenario, as interest rate expectations rise in the US while staying low in Japan, the gap between US-Japan interest rates widens, encouraging investors to favor holding dollars over yen, thus contributing to the depreciation of the yen's exchange rate.

In terms of foreign trade, Japan is grappling with evident weaknesses in exports, growing dependence on imports, and the issue of production offshoring.

Due to fluctuations in global market demand, changes in the international trade environment (such as rising protectionism and supply chain disruptions), and shifts in industry competition dynamics driven by technological innovation, Japan's exports are facing significant challenges. As a resource-poor island nation, Japan heavily relies on imports of energy and raw materials. With fluctuating international energy prices and the need for adjustments in domestic industrial structure, import costs have increased. Particularly concerning energy security, when international energy prices rise, it directly amplifies import expenses, further widening the trade deficit.

The chronic existence of trade deficits in Japan, coupled with sluggish domestic demand leading to a lack of momentum for repatriation of profits from Japanese companies' overseas investments, these structural issues also contribute significantly to the depreciation of the yen.

Japan's government debt-to-GDP ratio has consistently climbed since 1990, surging from 69% to 261% by 2022, making it the country with the highest debt ratio among major global economies, far surpassing that of the United States, France, Germany, and others.

The Japanese government's debt primarily consists of national bonds, nearly all domestically issued, with the Bank of Japan being the largest holder, effectively implementing fiscal deficit monetization policies. This proportion notably escalated after the initiation of Quantitative and Qualitative Easing (QQE) and Yield Curve Control (YCC) policies. There are several specific reasons behind this:

1. Chronic Fiscal Imbalance: Since the asset price bubble burst in the early 1990s, Japan's economy entered a prolonged period of stagnation often referred to as the "Lost Two Decades." During this time, the government continuously expanded fiscal spending in attempts to stimulate the economy, improve living standards, and cope with the mounting social security pressures brought about by population aging. This resulted in annual fiscal deficits and a consequent escalation of government debt levels.

2. Economic Structural Issues: Japan's growth model faced difficulties in transitioning, with relative weakening in innovation capabilities, insufficient market openness, and rigidities in the labor market, all of which constrained economic potential and prevented the absorption of its massive debt stock through robust economic growth.

3. Burden of Interest Payments: With the total debt amount increasing, the Japanese government's annual interest payments have also been on the rise, creating a vicious cycle where new debts must be incurred to pay off old debts and their accruing interest, causing the debt burden to grow exponentially. Although fiscal policies during the era of "Abenomics" aimed to promote fiscal reconstruction and control deficits, their actual impact was limited, with the government debt ratio continuing to rise albeit with minor fluctuations. Moreover, the extensive economic stimulus measures implemented during the COVID-19 pandemic led to a significant further increase in the debt ratio.

For traders, amidst a clear downtrend for the yen, they can potentially profit by shorting the yen in the foreign exchange market. Here are a few products that either directly or indirectly allow for shorting the Japanese yen:

1. Foreign Exchange Futures Contracts: Investors can buy and sell yen futures contracts, using short positions in yen futures to express their expectations of yen depreciation.

2. ETFs: Certain ETF products are specifically designed to track the performance of the yen against other currencies, such as the U.S. dollar or a basket of currencies. By short-selling these types of ETFs, investors can indirectly short the Japanese yen.

This product is a leveraged ETF, particularly suitable for investors who aim to hedge against the risk of yen appreciation or seek gains directly from a depreciating yen.

It is specifically engineered to track the performance of the Japanese stock market while employing currency hedging strategies to mitigate the risks associated with fluctuations in the yen-dollar exchange rate for investors. The primary objective of this fund is to hedge against the foreign exchange risks that investors might encounter when holding Japanese equities, enabling them to focus on the stock performance of Japanese companies themselves rather than worrying about potential profits or losses caused by currency movements.

In the near-term outlook, a turnaround in the yen's performance is expected to be unlikely. However, if the Japanese government intervenes, leading to a Black Swan event, the aforementioned trading strategies may no longer apply, and instead could require a reversal, thus carrying inherent risks.