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Foreign Exchange

Dollar/yen to enter bullish phase on Japanese capital outflows, analysts say

The yen is likely to decline against the US dollar as outgoing Japanese capital flows are rising, say FX strategists from Nomura and Barclays Capital.

Yujiro Goto, a strategist at Nomura in New York, says Japanese companies are investing more cash in foreign assets after the March earthquake, with outward foreign direct investment (FDI) likely to increase to around ¥7 trillion ($87.5 billion) this year, or 1.3% of gross domestic product, driving the yen lower.

Goto estimates that the yen might drop to 85 per dollar by the end of the third quarter from its current level of 80.90. The forecast is based on the idea that Japanese companies have ample cash, business confidence is recovering and companies are concerned that the earthquake will slow domestic activity. Japanese outward FDI accelerated to ¥759.3 billion in April. And Takeda Pharamceutical Co's purchase of Swiss pharmaceuticals maker Nycomed meant a $13.4 billion outflow from that deal alone in May, Goto says.

“Japanese corporations are very active in FDI even after the quake hit the economy,” says Goto. “We expect outward FDI to remain high and to generate Japanese yen selling pressure in the FX market.”

While cash held by Japanese corporations reached ¥221 trillion at the end of March, $175 billion more than a year earlier, companies might prefer to invest abroad as they become more concerned about the attractiveness of Japan as a manufacturing base after the earthquake, he said.

Barclays Capital analyst Masafumi Yamamoto says the yen is likely to trade at between 79 and 83 per dollar in the coming months. He points to the outward payment in securities investment income in June, bringing a seasonal decline in Japan's income surplus, which usually makes up more than half of the current account surplus. The flows mainly represent a rise in dividends or income from equity, rather than income from debt such as coupon and interest-rate payments, he says.

“A June spike in outflows also tends to be followed by a reduction in these flows in July, suggesting renewed upward pressure on the yen, other things being equal,” Yamamoto says.

US-Japan yield gaps are likely to remain flat in the coming months. While the US economic recovery might not be sufficient to prompt monetary policy normalization by the Federal Reserve, a double dip is not expected either, he says.

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