It is no secret that one of the primary drivers of relentless S&P 500 levitation over the past two years, ever since the start of Japan's mammoth QE, has been the use of the Yen as the carry currency of choice (once again as during the credit bubble of the early-2000s), whose shorting has directly resulted in E-mini levitation. One look at the intraday chart of any JPY pair and the S&P500 is largely sufficient to confirm this. Those days, however, may be coming to an end, at least according to Goldman which overnight released a note saying that the Yen is "Almost at breakeven: Further yen depreciation could be a net burden."
Here are the highlights:
The yen has depreciated quickly beyond ¥115/US$ from the ¥107/US$ level since the FOMC made the decision to terminate quantitative easing and the BOJ surprised with additional easing at the end of October. This has prompted concern over possible damage to Japan as a whole if the yen weakens further.
Using industry input/output tables to investigate the costs and benefits of a weak yen, we find that the manufacturing sector still reaps forex translation gains under Japan’s current economic structure. However, in materials and nonmanufacturing industries that have limited opportunity to pass on forex-driven cost growth to exports, the costs of a weak yen far outweigh the benefits. According to our calculations, a 25% decline in the yen’s valueresults in a ¥4.1 tn net cost increase for Japanese industry as a whole since 2012 and a ¥10.5 bn increase in household sector import inducement.
By contrast, the decline in commodity prices is a substantial relief. A 10% decline in commodity prices cancels out the increase in net cost borne by 14.5% yen depreciation. The 25% decline in commodity prices so far (oil price) offsets the net cost increase borne by 35% yen weakness. Calculating from the late 2012 rate of ¥78/US$, 35% depreciation works out to a rate of ¥120/US$. In other words, the combination of the oil price around US$80/bbl and the yen exchange rate of ¥120/US$ is just about at breakeven, netting out the benefit and cost of yen depreciation and oil price decline since Abenomics began.
That said, our commodities research team sees limited scope for further decline in crude oil prices, while we expect the yen to depreciate further as the FRB and BOJ’s policies diverge. If further yen depreciation is not accompanied by real economic growth in the form of an export volume recovery and broad wage increases, and ends up merely producing forex translation gains, we believe it could very well place an increased burden on the Japanese economy as a whole. Needless to say, the cost burden will ease if the rapid decline in oil price over the last few days stabilizes at the low levels.
Oddly enough, one can almost make the case that the collapse in crude price has been manufactured to allow Japan's QE to continue as long as possible. And yet, this is hardly comforting news to Japan's companies, which as shown in the chart below, are seeing a surge in bankruptcies unseen in recent history. This is how Goldman explains this:
For the nonmanufacturing sector, yen depreciation means growth in net cost, increased burden for corporate and household sectors
Nonmanufacturing industries export little. Most of the goods they produce are consumed domestically. Imported intermediate products used as raw materials in the nonmanufacturing sector amount to only ¥8.6 tn, but we estimate that depreciation-linked input cost is ¥40.3 tn as this includes electricity/gas used at retail stores and event spaces as well as fuel (oil) costs for transporting goods. Nonmanufacturing sector exports, meanwhile, amount to just ¥18.5 bn. A 25% decline in the yen’s value raises the input cost by ¥10.1 tn, but this far exceeds the additional export receipt of ¥4.6 tn, resulting in a net cost increase of ¥5.5 tn. This additional cost must be borne by the “domestic sector” in Japan—i.e., the corporate or household sector.
Keeping personnel costs in check is key for companies forced to bear increased costs due to yen depreciation. Personnel costs have a high weighting in the nonmanufacturing sector, and if the yen continues to weaken it will be difficult to continue raising wages unless sales rise commensurately with cost increases. Cost increases in the nonmanufacturing sector due to yen depreciation have an ultimate ripple effect on the household sector because the higher costs are passed on to retail prices and/or they prompt companies to rein in personnel costs (see Exhibit 2).
Costs of yen depreciation outweigh benefits for industry as a whole: Policies for addressing weak yen effect appear limited based on past experience
A similar calculation made using input/output tables for 2005 results in a “net export” figure of ¥16.3 tn for the manufacturing sector. Even after subtracting nonmanufacturing sector “net cost” of ¥14.9 bn, net exports of ¥1.4 tn remain, indicating that policies to offset the impact of a weak yen had a positive impact on the Japanese economy as a whole. The secular rise in crude oil prices from 2005 significantly raised the cost of intermediate inputs—mining, oil, and coal products—for both manufacturing and nonmanufacturing. For industry as a whole, input costs affected by yen depreciation increased to ¥86.6 bn in 2012 from ¥71.8 tn in 2005. Over the same period, exports of goods and services from Japan declined to ¥70.3 tn from ¥73.2 tn due to yen appreciation, the global financial crisis, and the March 2011 earthquake. The lack of growth in exports is due partly to the global demand cycle, but a larger structural factor is that Japanese companies have lost global market share due to the shift of production overseas and increased competition with foreign products.
In 2012, the structure of the Japanese economy was that manufacturing sector had net export value of just ¥5.5 tn, which was insufficient to offset the nonmanufacturing sector’s net cost of ¥21.8 tn, resulting in net cost of ¥16.3 tn for Japanese industry as a whole. A 25% decline in the yen’s value raises industry’s net cost burden by ¥4.1 tn, which is equivalent to 0.8% of GDP. The impact of weak-yen policy measures based on experiences when Japan was a net exporter, has clearly diminished.
Bankruptcies precipitated by yen depreciation on the rise
According to a recent bankruptcy survey by Tokyo Shoko Research, there were 214 bankruptcies due to the weak yen in January-September 2014, which is 2.4 times the 89 seen in January-September 2013. Far more of the bankruptcies were in the nonmanufacturing sector—81 in transport, 41 in wholesale trade, 19 in services, and 11 in retail—than in the manufacturing sector (44), which is consistent with our analysis based on the input/output tables.
Surprisingly, the number of bankruptcies since 2013 due to yen depreciation far surpasses the number of bankruptcies in 2009-2011 due to yen appreciation. Presumably, in many cases in 2009-2011 the strong yen was not cited as the direct cause of bankruptcy because there were numerous other factors at work also, beginning with the sharp slowdown in the global economy and financing difficulties. Nevertheless, the 353 bankruptcies since 2013 attributed to the weak yen are 2.2 times greater than the 157 bankruptcies from 2009 to 2011 attributed to the strong yen (see Exhibit 3).
And it is not just corporations that are approaching their weak-yen breaking point. So are households:
Household burden increases with weaker yen
Let us turn to the household sector. The input-output table has a matrix of “import induction value by final demand categories”. This shows the value of goods and services imports induced by final demand categories such as household consumption, private business investments, public fixed investment and exports (see Exhibit 4).
Household sector final demand totaled ¥279 tn in 2012, with imports accounting for ¥41.9 tn, or 15.0%, of household consumption. This includes gasoline and mineral fuels (oil, coal) needed to generate electricity for households. Taking into account the decline in the yen’s value since 2012, household sector import value has risen ¥10.5 tn to ¥52.4 tn. The ¥10.5 tn rise is equivalent to 3.6% of 2012 household sector disposable income of ¥287 tn.
In 2005, imports represented ¥32.8 tn of household final consumption. This figure rose ¥9.1 tn to ¥41.9 tn in 2012, and if we take the 25% decline in the yen’s value into account, the rise comes to ¥19.6 tn over seven years. Mining, oil, and coal products account for 50% of the rise since 2005, clearly showing how the rises in gasoline, kerosene and electricity prices due to yen depreciation increased households’ burden.
Household final consumption was largely unchanged during this period, rising just barely from ¥277 tn in 2005 to ¥280 tn in 2012. This means that domestic consumption of goods and services declined to the same extent that import consumption value increased. Disposable income declined just slightly over this period, to ¥287 tn from ¥290 tn, meaning that the rise in import costs for households due to yen depreciation was borne directly by households, causing them to curb their spending.
Food and fuel-related imports in the household sector totaled ¥22 tn in 2012, accounting for 54% of household sector imports of ¥41 tn. The recent decline in crude oil and other commodity prices is partially offsetting the impact of the weak yen, but not the rise in costs due to yen depreciation on the 46% of imports that are not food or fuel-related.
If further yen weakness is not accompanied by real economic growth in the form of an export volume recovery and broad wage increases, and ends up merely producing forex translation gains, we believe it could very well place an increased burden on the Japanese economy as a whole. Needless to say, the cost burden will ease if the recent rapid decline in oil price stabilizes at the low levels.
Needless to say, none of this is preventing the momentum-chasing algos to push the USDJPY up some 100 pips in the overnight session to offset the tumble in energy companies and push the S&P higher, and send it almost back to the highest level seen since 2007. And once the USDJPY trigger the 119 buy stops, all bets are off, if only for the Japanese economy. The Nikkei and the S&P 500 on the other hand, well those will keep rising as more economic devastation rains on Japan's economy thanks to Abenomics.
Then again, with Paul Krugman now openly advising Abe, it should come as no surprise that Japan's economy is in the late stages of a total and unprecedented collapse.