Japanese assets, such as the yen and the country's indices and stocks, are vulnerable right now.
After struggling with deflation for more than twenty years, Japan is seeing rising inflation. The more than two decades of deflation posed a challenge for the Asian nation. Consumers may be happy about falling prices, but such an economic environment raises the risk of a negative cycle. In such a scenario, companies cut investments and expansions, ultimately leading to less employment and lower wages. In the long run, it may be more “costly” to consumers to have lower prices, which at first may hurt only company profits, but also end up hurting consumers’ pockets even more than the lower prices for goods and services help them. ( source: bloomberg.com)
Moderate inflation, therefore, could be healthy for economic growth, as increased company profits tend to lead to expansion, which increases job opportunities and higher wages. However, Japan is at risk of entering a vicious cycle, in which inflation could continue rising, as the yen continues to lose value. Higher inflation could also lead to a further selloff in other risk assets, such as the country’s stocks.
The country’s wholesale inflation reached an almost 13-year high in August. The reason that inflation has managed to even pervade a country that has struggled with the opposite problem for so long is seen to be its reliance on Oil imports. Japan was the world’s fifth-largest Oil consumer and fourth-largest Crude Oil (CL) importer as of 2019, according to the U.S. Energy Information Administration. The rising energy prices require using more of the country’s currency to pay for the imports. Paying with a currency is the same as selling it. That increased supply over demand of yen pushes the price of the currency lower. The fact is, rising energy prices have been accompanied by a falling yen.
Moreover, this negative cycle of rising energy prices, weighing on the Japanese yen, may have further negative implications for the country’s economy. Japan’s consumer prices stopped falling in August for the first time in 13 months, ending Japan’s longest period of deflation since 2011.
While ending deflation is good for economic growth, if this trend of rising inflation continues, it could slow down investments and job growth. If that happens, company profits may suffer, potentially leading to further equity and index selloffs.
Japanese Currency and Assets Pushed Downwards
Let’s compare Japan’s benchmark’s and currency’s performance to its peers in the recent selloffs.
The Nikkei 225 (Japan 225) Index is down almost 8% in its recent decline, since its September 14 high till Tuesday. At the same time, the S&P 500 ( ES) fell by 1.8%. The Europe 50 (FESX) is down about 2.5%, and the China A50 (CN) has lost about 4% in the same period, from its September 14 high till today. In other words, Japan’s leading benchmark lost more than double the value than did the second-worst performer, Europe’s popular gauge.
Now, let’s look at how currencies have fared relative to the U.S. Dollar Index (DX) as a benchmark. The USD/JPY is worth 3.3% more than it did since September 14th. The EUR/USD dropped by 2.1%. The GBP/USD is down by 1.6%. The USD/CHF rose 0.85%, during the same time. Finally, the USD/CNH edged up by about 0.25%.
As we can see, both Japan’s currency and its main index underperformed compared to other countries’, demonstrating the impact of the rising energy prices on the energy importer. The question is whether inflation will continue to rise, increasing its pressure on a country that has been mired by the opposite problem, stagflation, or will it temper, allowing the yen and the country’s stocks to add value.