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Last updated: December 12, 2012 5:59 pm
When Tokyo equity traders do their morning reading in, there is one nugget of information to which they are sure to pay close attention: the level of the yen against the South Korean won. When the won rises against the yen, Japan’s broad Topix index is lifted on the perceived improvement of Japanese exporter competitiveness.
Recent form suggests good news for Japan bulls. The once-unstoppable yen has been Asia’s worst performing currency this year, down more than 7 per cent against the US dollar partly on expectations that the general election this weekend will usher in a change in how Japan battles entrenched deflation and shrinking exports. The Liberal Democrat party, which polls predict will be returned to power, has called for “unlimited” monetary easing.
The yen’s fall against the dollar pales in comparison to its tumble against the won: it has fallen 13 per cent against the Korean currency in the year to date.
Although the won remains far weaker against the yen compared with levels before the 2008 global financial crisis, a lasting shift in the relative value of the two could have profound implications for both economies.
“A little inflation and a weak yen could be tremendously supportive for some Japanese businesses,” says Robert Horrocks, chief investment officer at Matthews Asia, an asset manager. “I think it could happen faster than people currently appreciate.”
The rise of the won has chimed with a more general flow of capital into Asia following the latest round of quantitative easing in the US in September. As a large, liquid market with a high credit rating, Korea has attracted particular interest.
Société Générale has made the won, which is nudging 15-month highs against the dollar, its top pick among emerging market currencies, expecting gains to continue over the next year.
One big question has always been just how much appreciation in the won Seoul would tolerate. South Korea has a history of intervention in the currency market, which the finance ministry insists is to smooth volatility rather than halt gains. Authorities have also introduced a withholding tax on bond investments by foreigners and a cap on banks’ forward positions in the won to cool speculative demand.
The South Korean presidential election next week could herald a shift in policy makers’ attitudes toward a strong currency.
Both leading presidential candidates are promising more support for households and small businesses. Wai Ho Leong, an economist at Barclays, reckons that means the next administration is “likely to be more tolerant of won strength” as it seeks to help small companies that are more sensitive to import prices than those of exports. “Direct intervention will become more light-handed, and FX policy more laisser faire,” Mr Leong says.
For their part, large South Korean manufacturers play down the short-term impact of a rising won, saying they have hedged extensively against currency risk.
Meanwhile, bets on a weaker yen have accelerated as investors weigh the impact of more pressure on the Bank of Japan from a new government, along with the prospect of a new BoJ governor by April.
“We think . . . the BoJ will be compelled by the administration to inflate more aggressively,” says David Baran, Tokyo-based co-head of hedge fund group Symphony Financial Partners, describing the election as “a major turning point”.
To Yunosuke Ikeda of Nomura, however, the personnel changes are a sideshow; the fundamental balance of supply and demand is more important to the direction of the yen, says the head of FX strategy at Japan’s largest brokerage.
By the next fiscal year, four of the five biggest influences on the yen will be negative, says Mr Ikeda, citing the trade deficit, persistent outward foreign direct investment flows, and a likely increase in selling of yen assets by mutual funds and life insurers. Together, those flows imply net sales of Y7.3tn for the year, estimates Nomura – a significant reversal from the Y3.5tn net buying in fiscal 2010.
Nevertheless, the path ahead may not be smooth. Paul Mackel, head of Asian FX research at HSBC, says Japan faces an “uphill battle to engineer yen weakness when other central banks are being very dovish”.
The flow of foreign capital into Japanese equity markets that follows periods of yen weakness is also likely to require Japan to be “more aggressive than ever” if the yen is to continue its downward trend.
Additional reporting by Song Jung-a in Seoul
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