Japanese investors yet to jump into the yen mineshaft
The fall in the yen since the Bank of Japan (BoJ) last week surprised the market with plans to double its monetary base has been stunning, but domestic investors have yet to materially participate in the move.
As traders will testify, it has been in late New York sessions during the past few days that the market has been pushing the yen down to fresh lows.
Still, the weakness in the yen has been striking, with the currency dropping 6% against the dollar and 7% against the euro since Thursday’s announcement.
It has not just been the yen that has fallen – long-dated global interest rates have moved sharply lower, including yields on Spanish, Italian and French 10-year government bonds, which fell despite concerns over the eurozone debt crisis.
The market, in other words, appears to be betting that some of the cash injected into the Japanese system is going to leak out, with Japanese bond-buying flows supporting asset prices across the globe and, given the price action, the euro in particular.
However, evidence so far suggests it has been hedge funds outside of Japan that have been largely behind the four-month-old rally in USDJPY.
As the chart below from UBS shows, it has been outside of Tokyo hours that the lion’s share of yen selling has occurred. Although there has been a pick-up since last week’s policy decision from the BoJ, yen selling during Tokyo hours remains half-hearted.
Gareth Berry, strategist at UBS, says as far as yen selling is concerned: “It is abundantly clear that Japan’s $25 trillion real-money community has still not joined in with both feet.”
|USDJPY rally mostly foreign-driven|
If real-money Japanese investors do join in, then the potential for further yen weakness will increase markedly.
So far, however, it is unclear whether the fall in bond yields, in the eurozone periphery for example, represents a shift in the behaviour of Japanese real-money managers or whether hedge funds are front-running the expectation of Japanese inflows.
Certainly, some doubt whether Japanese real-money managers, happy to receive just above zero rates for decades, have suddenly developed a penchant for peripheral eurozone government debt.
Maurice Pomery, chief executive at research firm Strategic Alpha, says there has been some substantial selling in the JGB market, but it is unclear how fast “monolithic” Japanese real-money managers, such as life insurers, will or can move and how much risk they will be prepared to take.
“For the Japanese I can see that US yields at 1.75% look attractive, and the biggest bond market on the planet comes with some security, but getting greedy and ploughing into French, Belgian and other EU peripheral debt seems rather un-Japanese to me,” he says.
Indeed, for Pomery, the relatively muted rise in EURJPY compared with the fall in peripheral bond yields suggest it has been European hedge funds, not Japanese real-money managers, that have been most active in the market.
Some believe yen weakness through the leakage of funds abroad from the BoJ’s massive monetary policy expansion is unlikely to materialize in any case.
The theory goes that the injection of cash into the Japanese economy will leak out into foreign assets because, as the BoJ purchases bonds from the private sector, the cash they receive is invested in other assets, including foreign bonds.
Jennifer Hau, FX strategist at Lloyds Bank, concedes it is hard to oppose the yen weakness generated by the BoJ’s policy action for now, and that a move above ¥100 in USDJPY seems on the cards in the short term.
However, she warns that the previous big increases in central bank balance sheets seen in the financial crisis – from the US and the UK – have not had any obvious sustained FX, inflation or even broad-money impact.
Hau issues three caveats to the theory that “leakage” from the BoJ’s monetary expansion will weaken the yen in the longer term.
First, for investors in domestic bonds, the currency risk of purchasing un-hedged foreign assets would represent a huge increase in the risk profile of Japan’s real-money managers, a risk few are likely to take.
Second, for those investments to take place, the BoJ’s plans to massively expand the supply of narrow money by expanding its balance sheet will have to feed through into broad-money growth in the first place.
There has been little evidence, she says, that the big asset purchase plans seen around the world have been particularly successful in creating broad-money growth.
Third, and perhaps most tellingly, as the chart below shows, there is no evidence that the monetary easing undertaken in Japan has encouraged those leakage flows abroad.
“So far in Japan the anticipation of the big easing has led to a big inflow of capital into Japanese equities and bonds,” says Hau.
“And in any case, the fact that such flows tend to be inversely correlated with the yen doesn’t suggest that any outflow could necessarily be expected to be yen negative.”
|Japanese asset flows and USDJPY|
For now, the sheer size of the BoJ’s policy easing is putting pressure on the yen, but once the excitement dies down, the currency might cease to be a one-way bet.