On Friday, in its semi-annual currency report to Congress, the US Treasury highlighted China, Japan, South Korea, and Germany for relying on policies that give them an unfair advantage which has resulted in excessive current account surpluses.
This list of countries will not come as a surprise to regular readers as we have highlighted on several occasions that these four countries have the largest current account surpluses in the world. The fifth largest current account surplus country is Holland, not mentioned by the US Treasury, with a current account surplus of around 9% of GDP!
The combined current account surplus of these five countries is US$916 bn and growing rapidly, which is clearly excessive. If continued, the rest of the world will be amassing debt to the tune of almost US$1 tn to just these five countries. With the US economy showing signs of weakness, it is not surprising to us that the yen and euro are strengthening against the dollar and we expect the renminbi to follow this trend in due course.
Last week, with high expectations for the BoJ to ease further after the recent strong rally of the yen and weak core inflation readings, the central bank left its three key easing tools unchanged catching some investors off guard. The central bank’s inaction did little to help the continued strength of the yen which breached the ¥108 level on the day (in London trading hours), soaring ~3% against the dollar. It has since broken ¥106.
Back in January the BoJ’s adoption of negative rates took the market by surprise, again, it was not a popular move and was in fact counter-productive as the yen began its ascent against the dollar. This time round the bank has wrong-footed a number of investors whose expectations were for the central bank to deliver further monetary stimulus; especially after Governor Kuroda’s comment that the central bank “would not hesitate to take further easing measures” in order to reach its targeted inflation - which has consequently been pushed out, for the fourth time, into the next fiscal year.
The move has had little impact on our portfolios. We do however believe that the BoJ have actually missed a trick and markets are quickly losing confidence in the central bank. We understand the reasoning behind the BoJ’s decision to monitor the effect of January's negative interest rate decision over a longer term. However, the wrong signals have been sent to the market which expected the bank would, at the very least, expand its bond-buying program, and/or boost its ETF exposure and possibly go further into negative rates. In his statement post-announcement, Kuroda did comment that venturing further into negative interest rates was not off the table. What is however, is stimulus in the form of “helicopter money” which he said cannot be adopted “under Japan’s current legal system”. One has to wonder whether the central bank is running out of options. The market will now look to Prime Minister Shinzo Abe for any hints of fiscal stimulus to spur growth.
With the yen representing just under 15% of the renminbi basket, and the euro around 25%, gains in these currencies will undoubtedly lead to a stronger renminbi against the US dollar. With the Chinese bond market now the world’s third largest, the recent opening up of the bond market to international investors is likely to lead greater demand for renminbi going forward. Estimates vary, but a recent analysis by AXA Investment Management suggested that China could represent 18% of the Citibank WGBI index in due course. Unfortunately, many investors do not realise how underweight of renminbi they will be when China is included in the major indices. In our view it's not if, it is when that happens.