Happy Monday!

📝 Focus

• Land of the Rising Yen… and The Great Repatriation?

📊 In the Markets

• Hermès bucks the trend

📖 MoneyFitt Explains

🎓️  The Exchange Rate

📝 Focus

Land of the Rising Yen… and The Great Repatriation?

The Japanese Yen exchange rate🎓 may strengthen after a central bank policy change last Friday. The Bank of Japan (BOJ) kept short-term interest rates below zero but surprised markets by adjusting the Yield Curve Control policy that effectively capped 10-year Japanese Government Bond yields at 0.5%, saying the 0.5% ceiling was now a "reference" and "not a rigid limit"… though confusingly, there would be a limit at 1.0%. This change will, as we reported last Friday, impact the popular “carry trade” strategy.

..... ▷ The BOJ's shift signals a strengthening bias in the Yen, with some market watchers now looking at the low to mid ¥130s range against the US$ from about ¥141 today. The currency immediately saw some wild swings as traders tried to digest the implications of the shift, and ongoing volatility will likely have a knock-on impact across global markets.

..... ▷ In the carry trade, investors borrow cheaply in Yen to invest in higher-yielding currencies, like the US Dollar or Mexican Peso, profiting from the interest rate difference — which widened greatly during 2022. Though the Yen will likely remain a popular funding currency, carry trades would become both riskier and less profitable, taking out or reversing the marginal buyers of non-Japan assets.

..... ▷ The widening $¥ interest rate differential starting last year actually had an unexpected effect on bond investment flows as the cost of hedging against swings in the value of the Yen (using foreign exchange forward contracts) shot up as non-Yen interest rates soared. This drove currency-hedged overseas bond yields down below JGB yields, sending many Japanese investors in overseas bonds scuttling home.

..... ▷ As in most trading situations, the direction is set by a series of marginal decisions rather than a universal all-or-nothing call. On balance, higher interest rates in one currency relative to another tends to lead to the first currency’s strengthening. If the Yen is expected to appreciate, either quickly or gradually, that would be a challenge for global investments that have benefited from trillions of dollars in global liquidity that the BOJ has effectively exported. Japan’s outstanding net international investment position was $3.3 trillion as of this March (the Ministry of Finance reports total foreign assets at the end of 2022 at JPY1.34 quadrillion.) Some Japan watchers are warning that the “great repatriation” of Japanese investment flows, which already saw a record outflow in 2022 (see above), could accelerate.

📊 In the Markets

US inflation eases: US stocks were strong on Friday as inflation fell to its lowest level since the pandemic, reducing the chance of a September interest rate hike. The S&P 500 gained 1% for its third straight weekly increase, while the tech-heavy Nasdaq Composite surged 1.9% for its best day since May. Earnings season rolled on, with faded chip champ Intel up 6.6% on its return to profitability and Ford Motor down 3.4% despite beating estimates and raising guidance on weaker electric vehicle adoption due to higher costs. European stocks were mixed, with Germany's DAX reaching a record high. And then there was Hermès (see below.)

..... ▷ The June personal consumption expenditures index, the inflation measure preferred by the Fed, rose by 3%, down from 3.8% in May and in line with market expectations. The closely watched “Core” PCE index, which excludes volatile food and energy prices, eased to a 20-month low of 4.1%, slightly lower than the expected 4.2% but still more than double the 2% target. US wage growth also slowed in the second quarter. Having the headline figure below the core number suggests that food and fuel are likely to exert downward pressure on core inflation.

Hermès bucks the trend

Hermès, the iconic French ultra-luxury group, has defied the luxury sector’s slowdown in the first half of 2023, particularly in the US. Sales across all markets rose 22% from the year before to €6.7bn, and even more impressive, its industry-leading margins grew further, with operating profit for the period up 28% to €2.9bn.

..... ▷ This stands in stark contrast to its largest luxury sector peers, industry giant LVMH, LVMH-controlled Dior and Cartier-owner Richemont, which clocked growth of just 15%, 15% and 14%, and especially Gucci-owner Kering, which, at 2%, barely mustered up any growth at all. (Prada did 20%, Burberry managed 10%.) Investors worry that the luxury sector's crazy growth of recent years driven by pandemic-era savings, financial stimulus and revenge-spending sprees in China and the US, might be dropping off /normalising, particularly in the US (where both LVMH and Richemont recently reported troubling weakness.) But Hermès continues to buck the trend there with 20% growth, in part from the swish Upper East Side flagship store it opened on Madison Avenue in New York in October 2022, one of the largest Hermès flagships in the world. This boost will only fall off from year-over-year comparisons in results for the first half of 2024.

..... ▷ Just as importantly, demand from France and China remained strong, both at 24%, which is due to the related strategies of focusing on domestic sales (rather than hordes of retail tourists) and the local boutique-managed waiting lists for ultra-premium, high-scarcity items like Birkin (Jane Birkin RIP), Kelly and Constance bags. With unmatched status signalling and eye-watering price points, the strictly-controlled waiting lists (ranging from months to years, depending on the relationship with each individual store salesperson) also smooth out demand in a way its peers (with the possible exception of privately-held Chanel) have distinctly failed to match.

Chart-geek zone below: