Japan - Exporting Deflation?

It's been well publicised how the aggressive 'loose' monetary policy adopted by central banks is likely to be inflationary. The logic of this seems sound; they are printing trillions of dollars of money, and an increase in money supply should lead to inflation over the longer term.

Japan has recently undertaken extensive quantitative easing and has also directly attempted to depreciate their currency. One would presume this will cause inflation pressures; as mentioned above they have more money supply and also imports will become more expensive, thus importing inflation.

However, there is another take on this which I think is worth some consideration, and something I have not read too much about to date. Firstly we need to consider the Japanese economy. It is an export driven economy. Then we need to consider what a weaker Yen means for these exports. Well in essence it makes exports cheaper to foreigners who are importing them and this is the key to the deflationary pressures that Japan's latest policy could cause. So around the globe countries will be importing goods and services from Japan which are now cheaper, allowing businesses to lower prices and still maintain margins which could lead to deflation.

So what are the possible implications of this? Well the world has generally come to a consensus view that inflation could spike at some point due to the monetary stimulus mentioned above. However, if in fact Japan and other nations with weakening currencies are exporting deflation this may not be apparent, or at least to the extent markets are pricing in.

If you believe inflation may be 'overpriced' then one option is to 'short' inflation linked bonds whose returns are directly linked to inflation. Their price will fall if they have priced in too high inflation.

So for now lets hopefully look forward to some cheaper goods from Japan and be aware that high inflation is not yet a foregone conclusion!

Importing inflation

We have spoken previously about currencies and how a depreciating currency can be a benefit in many ways, not least making exports more competitive. However, one of the bi-products can be 'importing inflation'. 

Think about the price of petrol at your local garage, I bet it has become more expensive over recent weeks?! This is not due to a spike in the oil price, simply it's down to Sterling weakening against the USD and therefore making oil (priced in USD) more expensive. This will be occurring with many other imports, not just oil. 

It is often the case that with this type of inflation consumers do not fully feel the effects for a year or so, as prices do not change instantaneously, and so it could be that the real pinch of inflation occurs in 2014. CPI (consumer price index) last peaked in September 2011 at 5.4%. Given the poor state of the recovery it didn't lead to wage inflation. High levels of wage inflation can be very bad for businesses as costs (wages) spiral out of control. At this point in time I still don't feel employees have enough bargaining power to demand large wage increases should high levels of inflation occur, but it could be one to watch. Businesses with pricing power, which have the ability to pass costs onto consumers are normally desirable in this situation as they can maintain margins.

Having a strategy to implement in your portfolios to hedge against inflation could be something worth considering....

Currency and the Impact on your Portfolio

From my experience I have found that many investors (albeit retail) are often unaware of the impact currency movements can have on their portfolio, so I thought I would write a quick post highlighting just this...

When investing in foreign assets, be it debt, equity or commodities, not only are we subject to underlying price movements but also currency movements between our base currency and the foreign assets currency. Lets consider what happens when we buy a US equity fund. We hand over sterling, which is converted into US Dollars and then used to purchase the equities. When we redeem, we sell equities in US Dollars, convert this back into sterling and withdraw our cash. So if the US Dollar strengthens against sterling over the period we 'win' and if it weakens 'we lose'. It's just something one should to be aware of, particularly when many developed nations are actively trying to devalue their currencies.

So you may find the current weakness of Sterling frustrating when travelling abroad, but if like me you are holding foreign equities it can provide a nice kicker to portfolios! Beware, currencies can move quickly in both directions. It is possible to hedge out currency risk by purchasing a hedged share classes when investing in funds, or you could look to add currency trades into portfolios, but these can be costly and difficult to implement. For now let's just enjoy the ride...