For many in the U.S., a strong currency sounds like a nice problem to have. A firm greenback effectively reduces the cost of flat-screen TV’s from Asia and makes overseas vacations a little more affordable. In reality, however, currency strength can be an significant obstacle to economic growth, especially for export-dependent economies. No one knows that better than Naoto Kan, the Prime Minister of Japan who recently took office in a country that has fallen into a decades-long economic malaise, thanks in no small part to a stubbornly strong currency.
With general risk aversion running high, investors have flocked towards safe haven investments. And despite Japan’s economic struggles the yen still stands out as a safe harbor during economic storms, especially with the U.S. recovery showing signs of cracking. The yen recently reached a level of about 83.60 per dollar, that highest value for the Japanese currency in more than 15 years. That prompted calls for the government to step in provide relief , as countless Japanese executives expressed opinions that current exchange rates make the economics of their businesses incredibly challenging [also see Three Reasons Why Japanese Yen ETFs Are Headed For A Crash].
Late last week, it seemed that the stars were aligning for a push to weaken the stubbornly strong yen. The Bank of Japan called an emergency policy meeting for Monday, prompting Governor Masaaki Shirakawa returned to Tokyo from a Federal Reserve symposium in Jackson Hole, Wyoming a day ahead of schedule.
But the results of that meeting surprised some investors, as the central bank announced that it would essentially ease into stimulus measures. Kan said Japan will spend 920 billion yen ($10.8 billion) on economic stimulus and the central bank expanded a loan program by 10 trillion yen ($116 billion), falling short of consensus expectations. The overnight lending rate held steady at 0.1%. “Neither the BOJ nor the Ministry of Finance has yet to come up with strong measures to prevent the yen from strengthening,” said You-Na Park to BusinessWeek. “That means the market will continue to test the BOJ.”
ETFs To Watch
Monday’s developments gave additional fuel to the yen’s impressive rally, sending the Japanese currency sharply higher against all major rivals. With the government seemingly indicating that it will refrain from intervening in currency markets the yen may continue to gain ground, much to the dismay of Japanese manufacturers who will see the cost of their goods to international consumers continue to rise [also read What's Gotten Into Yen ETFs?].
As this saga continues to play out, we profile four ETFs that could see big swings depending on the yen’s path [see all the ETFs which offer exposure to Japan by using our new Country Lookup Tool]:
- Rydex CurrencyShares Japanese Yen Trust (FXY): This fund is one of the most direct plays on the yen; its value generally rises and falls with the Japanese currency. Despite the massive debt burden shouldered by the Japanese government and near-zero interest rates, FXY has surged this year; the fund is currently up about 10% year-to-date after surging almost 1% on Monday.
- iShares MSCI Japan Index Fund (EWJ): This ETF offers exposure to large cap Japanese equities, many of whom view a strong yen as a negative development. The disappointing outcome of Monday’s meeting dealt another blow to EWJ, which has struggled to gain traction in 2010.
- ProShares UltraShort Yen (YCS): This leveraged ETF offers a way for investors to bet on a decline in the yen, seeking to deliver daily returns equal to 200% of the increase in the value of the dollar relative to the Japanese currency. Not surprisingly, this ETF has had a tough year; YCS is down almost 20% in 2010.
- WisdomTree Japan Hedged Equity Fund (DXJ): This ETF offers unique exposure to the Japanese markets; in addition to holding Japanese equities, it hedges out currency exposure through the use of futures contracts. As such, DXJ offers a way for investors to track the performance of Japanese equities solely attributable to changes in stock prices, without the impact of currency fluctuations [see Do You Need A Hedged Equity ETF?].
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Disclosure: No positions at time of writing.