Japan wants a weaker yen and will try to get it

Outlook:

Bloomberg reports the dollar halted a two-day drop because of the Fed minutes com-ing out this afternoon, with nobody wanting to be short dollars in case the minutes show some propensity to move up the First Rate Hike. This is balderdash. A re-examination or greater de-tail is fruitless—we already know the doves are winning, so to speak, regardless of one spectacular jobs report last week. We have zero evidence that the Fed is even remotely inclined to bring forward the First Rate Hike from “next summer,” which by any definition is not sooner than June 15. It could be a lot lat-er, too, depending on developments. What analysts are looking for is the arguments surrounding trans-parency, with some disliking the phrase “considerable period” and wanting to get rid of it altogether or making it mean something real, like “six months.” We say anyone who gets excited about the members debating the Fed’s use of language needs more work.

In fact, we may even want to consider that if the rest of the world is going into a slump, including pow-erhouses Germany and China, maybe the Fed pushes out the First Rate Hike. We have little or no infor-mation about how the Fed’s decision-making process incorporates information about foreign economies, although Mssrs. Volcker and Greenspan certainly paid close attention in their day. Let’s say conditions worsen. Would the Fed delay/postpone a hike? Maybe. Would the BoE? Probably yes. To count on to-day’s minutes trumping the real economy is silly.

On top of whatever else seeps out from around the edges of the IMF meeting (like Weidmann’s inter-view with the WSJ today), we have the start of earnings season (Alcoa), which normally merits a side glance from the FX crowd but could be far more important this time. For one thing, those companies dependent on commodity prices are seeing a persistent decline in prices, including the price of oil. This is a good thing if you are a commodity user and a bad thing if you are a commodity seller. It’s doubly bad if you are a seller since falling prices imply weak demand. Another point is that some critics say P/E’s are excessive and based on abnormally high earnings growth. The minute earnings return to a more realistic and historically normal trendline, prices will fall by more to restore the normal P/E. This argu-ment holds no water at all, of course. P/E’s go all over the place and stay at odd levels for long periods. It’s bad investment decision-making to buy/sell on expectations of P/E’s getting normalized.

The real equity market problem, from the perspective of the WSJ, for one, is that nearly half of the S&P earnings come from foreign operations, either direct sales from overseas subs or exports. The dollar’s rise is supposed to cut into those sales and earnings substantially. But we can think of six reasons before breakfast why this is a dumb argument. Exports, for example, are dollar-denominated in the first place. Plus, US companies generally hold $2-3 trillion in cash overseas. A stronger dollar, if it is seen as per-sisting, encourages repatriation. The tax dodge Washington invented a few years ago brought back some big sums (although almost none of it went to job-creation as intended).

Next, a trend change is why we invented hedging. Granted, US companies are unbelievably stupid about hedging. Detroit, in particular, says no one can forecast FX so hedging is always a waste of time. Euro-pean and Japanese companies are far more sophisticated and able to stabilize earnings year after year by using smart hedges. US companies were talked into using options by the banks but then can’t take prof-its when they have them because they would have to explain why a cost center like a treasury depart-ment is making money instead of spending it—they must be “speculating.” We were actually smarter about hedging in the 1980’s than we are today.

In sum, world conditions should favor a continuation of dovishness at the Fed, no matter what debate was held at the Sept FOMC over the “considerable time” language. Besides, with capital flowing to the safe-haven US and yields back down to 6-week lows, to speak of the First Rate Hike now is pretty silly. If the rest of the world goes back into recession, the US doesn’t necessarily follow but it sure doesn’t fail to pay attention. Risk aversion is growing. The FT writes “There is no worry that the US central bank may raise interest rates too quickly in the coming cycle: it is likely to err on the dovish side given the meek growth filtering in from Europe. Instead, there are fears that the Fed’s third huge programme of asset buying, known as quantitative easing, is due to finish this month. When the first two QE pro-grammes ended, this coincided with significant falls for Wall Street stocks.”

That brings us to another story—Japan and the yen. Analysts are overimpressed by talk (from the Health Minister) that diversifying the government pension fund will take longer than thought—stretching out any action from Q4 to year-end or Q1. This is chatter, not analysis. Secondly, everyone hangs on any word by any official about the yen. This time it’s a remark by PM Abe that the weak yen is harmful to small businesses and consumers. Well, yes. When you have a policy of competitive devaluation, you will hurt some sectors. Abe and Kuroda knew this going in. They are throwing a bread crumb to the vot-er, not announcing a change in policy. To extrapolate from “harming consumers” to “deferring more stimulus” is far too big a jump. They are more likely to improve the tax situation some more for the af-fected sectors than to reverse policy. Make no mistake—Japan wants a weaker yen and will try to get it. Everything else is noise. Besides, the capital flow--¥3.5 trillion out of yen and into dollars so far this year—shows that the devaluation policy is well understood by the parties that count—the fund managers and Mrs. Watanabe.

So, whether the correction ends today or next week, end it will. We are inclined to think it will go on a little longer—for a significant test at (say) 1.2750—but time will tell.