Toyota Beats Its Peers
To the surprise of the financial markets, on Tuesday, Japanese car maker Toyota reported a record increase in US automobile sales in the month of September.  Their 25 percent increase in sales far exceeded the 4.7 percent rise reported by the Ford Motor Company and the 3.1 percent drop reported by General Motors.   Although all of the major car manufacturers offered incentives last month, the weakness of the Japanese Yen has allowed Toyota to make their offers more attractive than their peers, which is one of the primary reasons why the company performed at the top of its sector last month.  Not only did sales for SUVs and trucks increase at Toyota, but so did demand for small cars and hybrids.  Over the past five months, the Japanese Yen has fallen significantly.  The US dollar ââ,¬â€œ Japanese Yen exchange rate rose from 109 to 118 while the Euro ââ,¬â€œ Japanese Yen rate rose from 140.50 to 150.50, which is just shy of its all time high (see chart below). 

The Benefits of a Weak Yen
A weak yen has great benefits for Japanese companies with overseas operations.  In the case of Toyota, as the US dollar increases in value against the Japanese Yen, each dollar earned by Toyota is worth more, which can add to a lot when the company repatriates its earnings and tallies up its profits.  For example, if Toyotaââ,¬â"¢s US division earned USD$500 million in 2006, at a USD/JPY value of 109 that would be worth 54.5 billion yen.  However, if the USD/JPY value increased to 118, that repatriated value increases to 59 billion yen.  This means that just because of currency fluctuations or the Japanese Yenââ,¬â"¢s decline against the US dollar, Toyota would have made an extra 4.5 billion yen or USD$38 million in profit, which is an advantage that US automobile manufacturers will not benefit from.  In fact, according to a recent study by Harbour-Felax Group, the USD/JPY exchange rate has increased Toyotaââ,¬â"¢s advantage over US automakers by $1,054 per vehicle. 

Benefits Reach Beyond the Auto Sector
Yet the automobile sector is not the only sector benefitting from yen weakness.  Many Japanese companies have overseas operations and the change in the USD/JPY value may help most of them as well.  Nintendo Company was the latest major Japanese conglomerate to raise its profit estimates.  They expect their second half profits to be 20 percent more than their prior forecast which follows a first half report that already came out nearly two times more than their initial estimates.  The strong performance was due to robust sales of their new portable DS player as well as foreign exchange gains.  Companies such as Nintendo frequently hedge currency risk in the event of sharp fluctuations in the Japanese Yen.  

Another great example of the benefits of a falling Yen is incentives offered by companies like Matsushita Electric.  They have been able to reduce their prices significantly while their competitors have not by offering special customer discounts.  A 42 inch TV offered Matsushita undercut its rival model at Samsung Electronics by $400 thanks to Matsushitaââ,¬â"¢s promotions.

Japanââ,¬â"¢s ability to threaten the competitiveness of domestic companies in other countries extend beyond the US.  The Euro has appreciated 36 percent against the Japanese Yen since the beginning of 2002. This has made Japanese goods increasingly cheap for Europeans and this cheapness is being reflected in underlying demand.  According to Eurostat, in the first 6 months of this year, the EU25 trade deficit with Japan grew from EUR15.2 billion to EUR16.4 billion.  Japan has become the second choice for European exports, next to China.  Eventually this should come to the benefit of the yen as a growing trade surplus will pressure the currency lower, but in the meantime the currency has yet to budge.

Expect Japanese Earnings to Increases across the Board
If the Japanese Yen continues to remain weak, expect this to be an exceptional year for corporate profitability in Japan.  As indicated by the fourth quarter Tankan report, businesses are already very optimistic.  Incoming economic data over the next few weeks should continue to improve and reflect the benefit that the weak Yen is delivering to the country as a whole.  Not only does it keep demand domestic, which the country really needs at this point, but it also boosts exports and increases the value of foreign earnings.  However, just as the weak yen can come to the aid of Japanââ,¬â"¢s economy, a strong yen can hurt it.  Therefore if the Japanese Yen value begins to reverse, expect margins to be squeezed and economic growth to slow.  For an export dependent country like Japan, currency fluctuations are very important.  This is the main reason why the government always has a tendency to step in when the yen appreciates and turns a blind eye when it depreciates. 

Kathy Lien is the Chief Currency Strategist at FXCM.