English muffins. Single malt whisky. Choco-whip toast spread. For several months now, Japanese shoppers have had to brace for the reality of global conditions hiking the prices of the nation’s most basic foods. Soy sauce, noodles and chicken will also be affected.
An intriguing question, as currency markets approach 2022, is what sort of risk this poses to the yen, as it passes into its ninth straight year below the ¥100/$ line and with continued weakness still a favourite bet of speculative money.
Official measures of underlying inflation have begun to show (after many years emphatically not doing so) Japanese prices gently creeping upwards. But, according to analysts at Nomura Securities, more visceral modifiers of public sentiment are surging.
The number of articles in the online edition of the Nikkei Shimbun business daily that focused on all types of price rises (241) was more than 330 per cent higher in November than in the same month a year earlier. The number specifically about food (45) was up nearly six times over the same period. However modest the price hikes portended in these stories, runs one theory on the FX trading floors, the impact on overall sentiment is something the Bank of Japan will ultimately need to reckon with.
As a possible signpost of that need, note the Nomura analysts, the market reaction to food companies announcing price rises has broken hard with tradition. In the past, food stocks rose on such announcements because of the expectation that the increases would convert into stronger profits. Since the start of 2021, that correlation has broken down. The equity market (whether correctly or not) is betting that this time consumer sentiment may really start to absorb inflationary concerns, behaviour will adjust and the dent to the foodmakers’ sales volumes will surpass any uptick in margins.
This new atmosphere — mostly unfamiliar in Japan for a good two decades — arrives at a time when most currency analysts are preparing their outlooks for 2022 and reflecting on a year in which the yen has fallen 10 per cent against the US dollar. For the lion’s share of 2021, they have traded between the ¥109-114/$ range, with the yen held at the low end of that since the summer as the US Federal Reserve has sounded more hawkish and the US-Japan yield spread has widened.
Accordingly, most currency desks have tended to treat the yen’s weakness over the past 11 months as a “natural” — and hence sustainable until further notice — phenomenon, driven by the fundamentals of world economic recovery, global inflationary pressures and widening diversion between Japan’s permanently low yields and their rising counterparts overseas. At no real point in 2021 did investors decide for more than a few days that the yen was cheap enough for a sustained buying spree. In fact, notes JPMorgan FX strategist Benjamin Shatil, a trade that short-sells the yen against the dollar has been one of the world’s most reliable expressions of investor expectations of higher US yields.
The emergence of the Omicron coronavirus variant, which threatens to shift those fundamentals, offered an interesting proof of that. Between the widespread acknowledgment of the new strain around November 26 and the yen’s 13-month high a week later, the currency rose almost 2 per cent — the sort of volatility that smacked of a crowded trade leaving some wrongfooted. This was not, as some jumped to say, the yen acting as a “haven”, but the sudden unwinding of some large yen shorts. Some of those have since tentatively returned, but will not do so in earnest until markets are convinced that it is rate differential fundamentals, rather than Omicron, back in the driving seat.
But that, argues Shatil, is where those rising Japanese food prices could step in next year — not as a base case for yen strength, but as a possible risk that could once again threaten a renewed build-up of shorts. If, in the coming months, commodity prices are still rising and the Japanese find themselves fretting over consumer prices and inflationary sentiment, would it still make sense for currency markets to depend absolutely on a permanently dovish BoJ and therefore a reliably widening yield spread?
While the central bank is unlikely to turn hawkish in any meaningful way, say FX analysts, it is at least plausible that it could respond to a shift in sentiment by modestly relaxing its “yield curve control” policy. This might not produce a long-term shift in the yen’s fundamentals, but it could leave a new volatility where one of the FX market’s most dependable trades once stood.