Risk Management

Japan Easing Magnifies Yen Exposures

The Bank of Japan’s more aggressive monetary policy causes a big move in the yen and threatens to deepen the losses for unhedged U.S. companies.
Vincent RyanApril 4, 2013

Companies with exposure to the yen-U.S. dollar exchange rate have possibly had a wrench thrown into their hedging plans this year as a result of the Bank of Japan’s new, more aggressive policy of monetary easing. After a period of yen strengthening, the Japanese Central Bank’s announcement to buy long-term government bonds to inject $1.4 trillion into the Japanese economy means (foreign exchange) FX rates could move drastically in the other direction.

The yen weakened to 94.77 to the U.S. dollar on Thursday, revisiting highs the currency hit in mid-March.

Companies with revenue streams from Japan that aren’t protected against yen volatility have a tough choice of whether to hedge now and try to minimize further losses. On the other hand, the prospect of more yen weakening could tempt well-hedged companies to take profits on in-the-money hedges that were established when the yen was as strong as 80 to the dollar.

“I advocated to clients to hedge their yen exposure when the yen was much stronger,” says Andre Ohanissian, a principal at Forex Capital Advisors. “At this point, if you take a look at what the yen has achieved and where it could go, it’s less of a one-side risk,” and therefore trickier. With the yen at 95, it could strengthen to 90 or rise to 100, whereas when it was below 80 in 2011 and 2012 “you knew the Bank of Japan was not going to let it go below 75,” he says.

The yen’s first-quarter weakening in relation to the dollar has already hit U.S. companies’ first-quarter earnings. Firms that did not hedge their yen exposure, likely from sales in Japan or financial investments held in yen (including U.S. company pension funds), are likely to show loses. But further yen depreciation is a question.

The central bank move would argue for a further weakening of the yen. And indeed, the reality is at 80 yen to the dollar the currency was trading at a significant premium to fair value, says Ohanissian. Central banks were buying yen to diversify their currency holdings, explains Ohanissian. China, in particular, had been a big buyer of yen. But that stopped six months ago.

There are also forces from the other direction, however. U.S. monetary policy has the same aim as Japan’s, and is unlikely to cause any strengthening in the dollar versus the yen.

More long-term, a change in investment flows could bolster the yen. Over the last 20 years Japanese families have been forced to invest abroad because of low interest rates at home, resulting in massive investment flows out of the country, says Ohanissian. But a large population of aging citizens in Japan now needs to cash out and turn their foreign investments back into yen.

It can be perplexing for CFOs. Short-term, currency markets contain a lot of noise, much more so than other markets, explains Ohanissian. “True economic fundamentals take a long time before they actually exert themselves on currency rates,” he says.

For non-financial companies almost all of whom are not speculating in FX the aim of hedging is to avoid any earnings hits from currency-pair volatility arising from the noise.  “It’s not just the economic gains and losses but also the effects on the perceptions of the quality of the business and its revenues,” Ohanissian says.

Right now, companies that have already hedged their yen earnings exposure would be wise just to continue rolling over their in-the-money hedges, says Ohanissian, although some may speculate a bit by reducing their hedges. On the other side of the coin U.S. companies that are not hedged have taken a beating, and the question is whether or not to put on a hedge now. Those companies may be reluctant to put on a hedge because they think it too expensive. But the yen could drop further, amplifying the estimated 17% mark-to-market losses such companies have absorbed to date.

One way to cheapen the cost of hedging yen exposure would be to use a structured strategy with options, says Ohanissian. That would involve combining the sale and purchase of yen options at different strike prices to establish a floor and ceiling on the price movements.

Complicating the picture, of course, is that U.S. companies may not have a good forecast of what their revenues from Japan are going to look like. With a weakening yen, goods from companies outside Japan become more expensive to Japanese businesses and consumers. So  a company could overhedge and take a hit to earnings, and if it’s a loss the CFO would have to explain that to the board. Some CFOs, therefore, find not hedging or under-hedging worth the risk, and would rather just call themselves the victim of larger market forces.

“Some companies hedge at all costs and others don’t know how to hedge,” says Ohanissian, “so in order not to make mistakes they plead ignorance and don’t do anything.”