Strong Yen and Plunging Commodity Prices: A Wash for Japan?

1.

The great global deleveraging has now spread to currencies, causing the yen to spurt temporarily to JPY90.5/USD, the highest since April 1995, when the yen hit a historical high against the USD of JPY70.5/USD. As the first chart shows, the Nikkei 225 index of Japanese stocks moves inverse to a strong yen, i.e., falls when the yen surges and rebounds when the yen sells off.



But now plunging commodity, prices, particularly crude oil, are a factor offsetting the strong yen. As the chart of Cosmo Oil purchase prices shows, imported crude oil prices for Japan basically tripled between 2002 and 2007, and in July 2008 surged to JPY15,000/bbl, threatening to create another "oil shock" of 1973/1974 proportions. However, yen-denominated imported oil prices have now plunged to 1/3rd July levels to JPY5,000, the lowest level in three years and five months.



At the peak of imported oil prices in July, Japan's oil imports were costing JPY22.2 trillion annualized, but now are only costing JPY7.8 trillion annualized. Every 10% move in the annual cost of imported oil boosts Japan's economy and corporate profits by several tenths of a percentage point and 0.7 percentage points, respectively.

Conversely, every 10% of strength in the yen,against the USD lowers corporate profits by around 3%, other factors being equal. In other words, average oil prices have to decline by about 40% to offset the negative impact of a 10% rise in the yen on aggregate corporate profits. In their FY2008 forecasts, however, Japan's major exporters like Toyota (7203.T) and Panasonic (6752.T) were assuming average JPY-USD exchange rates of JPY100~JPY105/USD versus a current quote of JPY97/USD (about 6%).

In terms of stock prices, stock prices of Japan's exporters discount the strong yen real timewhile the full impact on profits is felt a year-and-a-half to two years later. By that time, Japanese companies will be enjoying a windfall from sharply lower imported basic materials (commodities) costs, implying that the combined impact of the strong yen and falling commodity prices are basically a wash for Japan's economy and corporate profits.

Government "Emergency Measures" and Talk of Major Bank Capital Increases Spook Investors in Japanese Bank Stocks

Japan's Prime Minister Taro Aso and his cabinet are compiling a stimulus package to support the country's banks and the economy as the credit crunch and losses on mortgage-related derivatives roil financial markets and threaten to push the global economy into a recession.

Investors are pounding Japanese banks as unrealized losses on shareholdings held by the six leading banking groups swelled to 1.2 trillion yen Friday in the wake of the steep market sell-off. Losses are even larger on their broader securities portfolio, including bonds and securitized products. Economic and Fiscal Policy Minister Kaoru Yosano was quoted on national television on Sunday as saying the government should increase the amount of funds injected into mainly regional banks to JPY10 trillion. Japan's largest and strongest bank, Mitsubishi UFJ Financial Group is reportedly considering a capital call of JPY990 billion including the issuance of up to JPY300 billion of preferred shares in order to insure it can maintain a capital ratio of over 10%. The takeover of the remainder of UnionBancal Corp. and Morgan Stanley in the US involved tens of trillions of yen of investment, meaning that its capital ratio could significantly deteriorate. The BIS-required capital ratio for internationally active banks is 8%.

As Japanese banks still count unrealized gains/losses in their Tier 2 capital, they remain susceptible to heavy sell-offs in securities markets. Moreover, it appears that government "emergency countermeasures", ostensibly aimed at bolstering confidence in Japan's financial institutions and its economy--in combination with reports that Mitsubishi UFJ Financial plans a big capital increase, have sent the wrong messages, i.e., that investors do need to be concerned about the health of Japanese banks as well.