The yen is sliding again as instability in the Middle East deepens. On the 21st (local time), the yen-dollar exchange rate broke past the 163 yen per dollar level in the New York foreign exchange market for the first time in 40 years since 1986. The move reflected heightened preference for the dollar as a safe-haven asset amid worsening Middle East conditions, along with growing concerns about the Japanese economy, which is heavily affected by Middle East oil prices. By contrast, the Korean won showed a stable exchange rate trend in a similar environment, drawing attention to the reasons behind it.
Experts pointed to the weak yen as the biggest risk to the Japanese economy, while expecting active transactions such as mergers and acquisitions (M&A) to continue in the market. They also forecast that demand for long-term Japanese government bonds would increase as the weak yen boosts their appeal.
Why Did the Yen Plunge While the Won Stayed Stable?
According to the Nihon Keizai Shimbun on the 22nd, the yen exchange rate against the dollar, which had moved within a narrow range for about two weeks, turned to a downward trend from the early hours of the 21st in U.S. Eastern time, and fell below its previous low (July 1, 162.84 yen per dollar) around 10 a.m.
The cause is the growing fear of an all-out war with Iran. As the Middle East situation grew tense, moves to buy the dollar strengthened. The dollar index, which represents the comprehensive strength of the dollar against major currencies, rose to the 101 level, up 0.2 point from the 20th. Although the United States and Iran signed a memorandum of understanding to end fighting in mid-June, the possibility of another full-scale clash increased, and dollar buying gained the upper hand due to investors' risk-averse tendencies. On the outlook that inflationary pressure would spread to the United States as well due to rising oil prices, the yield on 10-year Treasury bonds, the benchmark for U.S. long-term interest rates, rose to the 4.6% range. This partly led to dollar buying aimed at interest income.
Given the characteristics of Japan's energy supply, which relies heavily on Middle East crude oil, concerns over a Red Sea blockade are fueling downward pressure on the yen. Atsuhide Sakamoto, senior economist at Sumitomo Mitsui Banking's New York branch, said that while dollar buying is the main cause of the recent weak yen, "the logic that rising oil prices increase Japan's trade deficit and lead to a weak yen will have an impact over the medium to long term."
Nikkei noted that one cause of the yen's abrupt fall to the 163 level was a flood of stop-loss selling triggered by the yen's plunge, at a time when yen buy orders had accumulated in anticipation of government intervention in the foreign exchange market.
Growing trade deficits also appear to have contributed by increasing dollar demand within Japan and lowering demand for the yen. According to trade statistics (preliminary figures) for the first half of this year released by Japan's Ministry of Finance on the 22nd, the trade balance—exports minus imports—posted a deficit of 1.0144 trillion yen (about 9.2 trillion won). Thanks to increased exports of items such as semiconductors, the deficit shrank 57.0% from the first half of last year, but June's trade deficit widened more than expected. The trade deficit before seasonal adjustment expanded to 406.9 billion yen from a 391.8 billion yen deficit in May. Market experts had expected a 120 billion yen deficit.
The dollar-won exchange rate, similarly affected by geopolitical instability in the Middle East and rising international oil prices, also traded at 1,479.1 won on the morning of the 22nd, up 5.7 won from the previous day's closing price. However, considering that the won's value has continued to decline this year, it is showing a more stable trend compared to Japan.
Analysts say hedging-related dollar selling by exporters and heavy industry companies, along with expectations of dollar supply from SK hynix's listing of American Depositary Receipts (ADRs) in the United States, capped the upper limit of the exchange rate. However, if offshore buying tracking dollar strength flows in, downward pressure on the won could grow further.
Stock Market Booming, but "Weak Yen Is Japan's Biggest Economic Risk"
John Waldron, president and chief operating officer (COO) of U.S. financial giant Goldman Sachs, said in an interview with Nikkei on the 21st that "the weak yen can clearly cause significant inflation," presenting the view that, excluding geopolitical risks, the weak yen is the risk with the greatest impact on Japan's economic growth and markets.
However, COO Waldron took an optimistic stance, saying the Japanese stock market is performing well and that M&A and private equity activity is also increasing. "In the past, activist shareholders in the United States pressured companies to focus on return on invested capital (ROIC), free up assets sitting idle on balance sheets, and expand share buybacks," he explained. "These elements, which characterized the first wave of U.S. activism, are becoming a feature in Japan today as well." He continued, "There are also moves by major Japanese companies to expand overseas investment, so I see the M&A business environment as favorable," and gave a positive assessment of the corporate governance reforms led by the Japanese government.
COO Waldron also pointed out that the appeal of Japanese government bonds is growing. "As interest rates have risen, an environment where you can seek returns from bond investment has returned," he said. "Today, there is clearly a yield curve in Japan." The yield on 30-year Japanese government bonds momentarily reached 2.9% early this month, a 30-year high. He observed that such conditions would also be favorable for foreign investors seeking to participate in the Japanese bond market, and that the scope for Goldman Sachs to broker transactions would widen as well.
However, an extremely weak yen is bound to be a long-term obstacle to the Japanese economy. Given the characteristics of the Japanese economy, which is highly dependent on foreign sources for energy and food, a sustained weak yen triggers a surge in import prices and aggravates inflation. As a result, households' real income falls and private consumption sharply contracts, putting the domestic economy under pressure of recession. In particular, unlike in the past, major companies' production bases have relocated overseas, so the effect of a weak yen increasing export volumes is negligible, while only import costs swell, raising concerns that the trade deficit could become entrenched, analysts say. The upward trend in government bond yields could also work as poison for the finances of the Japanese government, which carries an enormous debt.
