Transcript: A new day dawns for the yen

This is an audio transcript of the FT News Briefing podcast episode: ‘A new day dawns for the yen’

Sonja Hutson
Good morning from the Financial Times. Today is Thursday, March 28th, and this is your FT News Briefing. Disney and Ron DeSantis put aside their differences, at least for now. And Japan’s currency could get a whole lot more volatile. Plus, small-cap stocks have hit a low point. I’m Sonja Hutson, and here’s the news you need to start your day.

[MUSIC PLAYING]

Disney settled a long-running legal dispute over its Florida theme parks yesterday. The fight began back in 2022. That’s when Florida governor Ron DeSantis tried to end the company’s 50-year-old right to run its own government around Walt Disney World. DeSantis was gearing up to run for president at the time, and critics accused him of using his office to punish Disney for opposing his so-called “Don’t Say Gay” law. Disney has now agreed to drop many of its legal disputes and negotiate with a revamped board over future development plans.

[MUSIC PLAYING]

For years, the Japanese yen has been seen as a currency of choice for some investors. It has a unique position in foreign exchange markets, and a lot of that is thanks to Japan’s decades of ultra-low and even negative interest rates. But last week, the Bank of Japan made a big change. It finally raised interest rates above zero. Here to talk to me about what that could mean for the yen is the FT’s Aiden Reiter. Hi, Aiden.

Aiden Reiter
Hey, Sonja.

Sonja Hutson
OK, so explain this unique position that the yen has. I mean, why are certain investors so interested in it?

Aiden Reiter
Yeah, as you said, the yen has held this really interesting place in the global economy. The Bank of Japan has had an ultra-loose monetary policy. That means because they have been focused on keeping those rates low, they’ve not had to be so responsive to changes in the market. So the yen has been reliably around the same level. That has given the yen this unique position for investors and for the broader market because it allows people to do carry trades. A carry trade is when you take something that is, you know, a low-returning asset. It’s cheap to borrow in that. So people borrow in the yen and then sell the yen in order to buy other currencies that are higher-yielding or assets that are higher-yielding. So because of that, the yen winds up moving in a different direction to the rest of currencies and other parts of the economy when times are bad. So if the global economy is not doing well, people wind up going back to the yen because it is, you know, not as volatile as the rest of the market.

Sonja Hutson
Got it. So now that the BoJ has raised rates out of negative territory, could this make the yen a little bit more volatile than it has been?

Aiden Reiter
Yeah. What changes now is that the interest rates by the BoJ will be more data-dependent. So markets have to look out for and weigh whether or not the yen is going to change against other currencies and against other central banks’ interest rates. We’ve already seen that today. You know, actually counter to what most people thought would happen, the yen has depreciated a whole chunk in the past week. And that’s because part of what we’re saying with volatility, it’s not because of the interest rates rising, the yen is depreciating. It’s that ultimately the carry trade is still alive today because there’s a huge spread between Fed rates and between the Bank of Japan’s rate. So ultimately, the yen will become more volatile, but we’re not seeing the carry trade change so much today.

Sonja Hutson
Got it. So because Japan’s interest rates are still so low, especially compared to the US, we haven’t seen big changes in the way the yen operates yet. But Aiden, when theoretically the yen does start to become a little more volatile, what kind of impact would that have, both in Japan and globally?

Aiden Reiter
So one of the other, you know, interesting things of having, you know, low borrowing cost is the yen has been really important to emerging markets who need to access capital in tough economic times. That has been particularly true in the last two years. So you’ve seen them issue samurai bonds, which is when you issue a yen-denominated bond on the Japanese market. We saw that with Egypt in 2023, with Ukraine in 2022 and Kenya has announced plans to do the same. If the yen were to become more volatile and to appreciate in the coming years, that’ll make it harder for them to pay off their debt to Japan and Japanese banks, and it further takes away an option for them. The other interesting quirk of this is, you know, as the yen appreciates and as the yen starts to resemble other currencies, you’re not going to have as many people able to rely on the yen in bad times.

Sonja Hutson
Well, all right. Are there any upsides to the yen becoming a little more volatile?

Aiden Reiter
Yeah. Theoretically, they should appreciate in the long run. That’ll be great for Japanese households who will see the value of their currency increasing on global markets. It’ll also help Japan as it tries to, you know, buy imports from rest of the world. It also could be a benefit to Japan’s economy writ large. As interest rates get higher, you might see more Japanese capital, which is really invested around the world, coming back to Japan and further investing in its own economy.

Sonja Hutson
Aiden, what’s the timeline we’re looking at here? I mean, the BoJ just raised its rates last week. I think we’re at a range of like 0 to 0.1 per cent now, so not a huge jump. Exactly how much volatility could we be seeing in the immediate future?

Aiden Reiter
The reality is right now the carry trade and the things that make the yen unique are still very much alive, right? The yen has lower borrowing costs and the lower borrowing costs in Japan relative to most other economies. And ultimately, the Bank of Japan has been very dovish. They’ve, you know, not indicated they’re going to raise rates much faster at a higher clip in the coming years. So at this point, it’s really just going to depend on the other central banks, whether the Fed and the ECB come down in the next two years and become more aligned with the yen.

Sonja Hutson
Aiden Reiter covers economics for the FT. Thanks, Aiden.

Aiden Reiter
Thank you. 

[MUSIC PLAYING]

Sonja Hutson
Shares in small companies are vastly underperforming relative to those in big companies. These small-cap stocks used to be more popular with investors, but they’ve fallen off in recent years, and now the gap between small- and large-cap stocks is bigger than it’s been in more than two decades. Here to explain why is the FT’s George Steer. Hi, George.

George Steer
Hey.

Sonja Hutson
So back in the day, why were small-cap stocks so popular?

George Steer
Well over the very, very long term, fast-growing small caps have tended to deliver punchy returns for investors. They’re more volatile, but they’ve tended to do better than the big companies listed on the S&P 500. And that’s because if you get it right, if you pick the right small-cap stock, it can explode. So the potential returns on offer are big. 

Sonja Hutson
Mmm. When did that change then, like, when did investors start to lose interest in small caps?

George Steer
In 2014, when interest rates kind of were lower following the financial crisis, investors flooded into these big-cap stocks, and that meant that small-cap indices started to underperform and they are kind of reversal of that historical norm. The reason why big technology stocks did really well or have done really well over the past decade is they’ve been like some of the main beneficiaries of low interest rates, right? They have big projected potential future earnings and that investors were really focused on that when rates were low. Small caps, I guess, were perceived as riskier bets. So I guess it also reflects a rush by investors into the kind of like safe defensive stocks like Apple, which, you know, people are pretty sure are going to do well no matter what happens to the economy more broadly.

Sonja Hutson
What’s the outlook for these small-cap stocks going forward, especially since the US Federal Reserve is looking to cut interest rates this year?

George Steer
So a lot of the kind of small-cap portfolio managers, they’re quite optimistic that if the US avoids recession, the earnings for these smaller companies should improve. All while the earnings for the Big Tech stocks have driven bigger indices to record highs are set to kind of slow. So the gap that’s opened up between the two indices, small caps and large gaps, should begin to narrow.

Sonja Hutson
OK. So George, big picture, what does this dynamic mean for the overall health of the US stock market?

George Steer
I guess the big US stock indices like the S&P 500 and the Nasdaq Composite are at record highs. And that, as you said, has been driven by the Magnificent Seven, and really Nvidia and Meta at the moment. The small-cap stocks — the fact that they’re lagging — they they’re not think terribly, but they’re lagging — I guess kind of reflects the fact that we’ve got a bit of a kind of two-track economy right now. On the surface, things are great. The headline statistics show that the US economy is booming. If you look a little deeper, smaller companies aren’t doing quite as well. So I guess, yeah, the stock market shows it would become dangerous if suddenly Meta or Nvidia disappoint on earnings. The top-heaviness of this big index rally would end up coming back to bite it.

Sonja Hutson
George Steer is a markets reporter for the FT. Thanks, George.

George Steer
Thank you.

[MUSIC PLAYING]

Sonja Hutson
You can read more on all these stories at FT.com for free when you click the links in our show notes. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news. 

[MUSIC PLAYING]