Japan's focus on hedging any purchases of U.S. Treasuries, the downward dollar pressure from falling U.S. yields, the prospect of more Federal Reserve easing and the Bank of Japan's inaction on deflation all suggest the yen can remain strong.
Finance Minister Yoshihiko Noda stepped up his rhetoric on Tuesday by warning the yen's recent moves were clearly one-sided, but his remarks were not strong enough to stop traders from pushing it to new highs against the dollar on growing scepticism that Japan would intervene to curb yen gains.
Finance Minister Yoshihiko Noda stepped up his rhetoric on Tuesday by warning the yen's recent moves were clearly one-sided, but his remarks were not strong enough to stop traders from pushing it to new highs against the dollar on growing scepticism that Japan would intervene to curb yen gains.
TREASURIES AND FALLING YIELDS
Japanese investors, especially banks, have been huge buyers of U.S. Treasuries, especially in recent months.
The latest Ministry of Finance data shows Japanese investors snapped up 2.2 trillion yen ($26 billion) of U.S. sovereign bonds in June. Total foreign bond buying accelerated to $55 billion last month and has been hefty so far in August.
All things equal, such purchases would weaken the yen against the U.S. currency.
But Japanese banks tend to fund their Treasury buying with dollars via the U.S. repo market. Institutional investors such as life insurers are taking advantage of lower U.S. interest rates to currency hedge their purchases by selling dollars in FX forwards JPYF= -- thus neutralising the currency impact.
Still, the U.S. bond buying has been big enough to play a role in yields falling to 16-month lows, eroding the traditional U.S. yield advantage over Japanese bonds whose yields are also falling, though not at the same pace.
The spread between five-year Treasury yields US5YT=RR and JGB yields JP5YTN=JBTC has shrunk a full percentage point in the past four months, while the 90-day correlation between that yield spread and dollar/yen has climbed to a very strong 0.96 -- showing the role that yield spreads are playing.
The same is true for German Bund yields DE5YT=TWEB and euro/yen.
The deleveraging of banks has meant that many in major countries are increasing their holdings as a share of total assets, just as inflation slows and could turn into deflation -- keeping G3 yields under pressure relative to JGB yields.
YEN NOT THAT STRONG, REALLY
The yen's climb to a 15-year peak against the dollar and a nine-year high against the euro has spurred a barrage of warnings from Japanese officials about the dangers to the country's exporters and fragile economy.
The rise against those currencies has resulted in the yen's trade-weighted index -- or nominal effective exchange rate (NEER) -- hitting an all-time high.
The yen's inflation-adjusted index (REER) is at an 18-month high, but is still 32 percent below its 1995 peak because of falling prices in Japan for the better part of 15 years.
Of course, the relatively weak yen REER matters little for big Japanese firms that had planned for a dollar/yen rate closer to 90 this year and are scrambling to limit the hit to their earnings from its strength, on top of a slowing global economy.
YEARNING FOR YEN
One surprise this year has been foreign central banks finding a new place for the yen in their foreign reserves.
The bulk of overseas buying of Japanese assets this year has been in short-term money market instruments, as seen most clearly in China's record buying spree of Japanese debt.
Such demand for Japanese debt, either as part of foreign reserve diversification or due to investors seeking a temporary parking place for their money, has likely helped support the yen.
YEARNING FOR HIGHER YIELDS
While the yen has climbed broadly, it has not risen as much as higher-yielding currencies such as the Brazilian real BRLJPY=R and South African rand ZARJPY=R thanks mainly to sizable Japanese investment abroad.
Japanese investors shovelled $173 billion into overseas equities, bonds and money market instruments in January-July. Such overseas investments by Japanese investment trusts, or "toushin" funds, are heading towards higher-yielding currencies and emerging market assets rather than the dollar.
BOJ STANDS PAT, FED SEEN ACTING
The Bank of Japan has showed no inclination to fight the deflationary forces gripping the Japanese economy, even as the Fed looks poised to increase quantitative easing, and many market watchers believe it has little power to turn the tide anyway.
So far, increases in its special funding operations have done little to stem the yen's rise or spur bank lending.
The BOJ's total balance sheet size remains well below its quantitative easing peak in 2006, while the Fed's has nearly tripled since the collapse of Lehman Brothers.
The perception that the Fed may be more aggressive than the BOJ has been one factor undermining the greenback.
So in many ways, the yen's rise simply reflects that it is the anti-dollar and anti-euro among G3 currencies in a world where the developed world is struggling after the financial crisis but emerging markets are still thriving.
Japanese investors, especially banks, have been huge buyers of U.S. Treasuries, especially in recent months.
The latest Ministry of Finance data shows Japanese investors snapped up 2.2 trillion yen ($26 billion) of U.S. sovereign bonds in June. Total foreign bond buying accelerated to $55 billion last month and has been hefty so far in August.
All things equal, such purchases would weaken the yen against the U.S. currency.
But Japanese banks tend to fund their Treasury buying with dollars via the U.S. repo market. Institutional investors such as life insurers are taking advantage of lower U.S. interest rates to currency hedge their purchases by selling dollars in FX forwards JPYF= -- thus neutralising the currency impact.
Still, the U.S. bond buying has been big enough to play a role in yields falling to 16-month lows, eroding the traditional U.S. yield advantage over Japanese bonds whose yields are also falling, though not at the same pace.
The spread between five-year Treasury yields US5YT=RR and JGB yields JP5YTN=JBTC has shrunk a full percentage point in the past four months, while the 90-day correlation between that yield spread and dollar/yen has climbed to a very strong 0.96 -- showing the role that yield spreads are playing.
The same is true for German Bund yields DE5YT=TWEB and euro/yen.
The deleveraging of banks has meant that many in major countries are increasing their holdings as a share of total assets, just as inflation slows and could turn into deflation -- keeping G3 yields under pressure relative to JGB yields.
YEN NOT THAT STRONG, REALLY
The yen's climb to a 15-year peak against the dollar and a nine-year high against the euro has spurred a barrage of warnings from Japanese officials about the dangers to the country's exporters and fragile economy.
The rise against those currencies has resulted in the yen's trade-weighted index -- or nominal effective exchange rate (NEER) -- hitting an all-time high.
The yen's inflation-adjusted index (REER) is at an 18-month high, but is still 32 percent below its 1995 peak because of falling prices in Japan for the better part of 15 years.
Of course, the relatively weak yen REER matters little for big Japanese firms that had planned for a dollar/yen rate closer to 90 this year and are scrambling to limit the hit to their earnings from its strength, on top of a slowing global economy.
YEARNING FOR YEN
One surprise this year has been foreign central banks finding a new place for the yen in their foreign reserves.
The bulk of overseas buying of Japanese assets this year has been in short-term money market instruments, as seen most clearly in China's record buying spree of Japanese debt.
Such demand for Japanese debt, either as part of foreign reserve diversification or due to investors seeking a temporary parking place for their money, has likely helped support the yen.
YEARNING FOR HIGHER YIELDS
While the yen has climbed broadly, it has not risen as much as higher-yielding currencies such as the Brazilian real BRLJPY=R and South African rand ZARJPY=R thanks mainly to sizable Japanese investment abroad.
Japanese investors shovelled $173 billion into overseas equities, bonds and money market instruments in January-July. Such overseas investments by Japanese investment trusts, or "toushin" funds, are heading towards higher-yielding currencies and emerging market assets rather than the dollar.
BOJ STANDS PAT, FED SEEN ACTING
The Bank of Japan has showed no inclination to fight the deflationary forces gripping the Japanese economy, even as the Fed looks poised to increase quantitative easing, and many market watchers believe it has little power to turn the tide anyway.
So far, increases in its special funding operations have done little to stem the yen's rise or spur bank lending.
The BOJ's total balance sheet size remains well below its quantitative easing peak in 2006, while the Fed's has nearly tripled since the collapse of Lehman Brothers.
The perception that the Fed may be more aggressive than the BOJ has been one factor undermining the greenback.
So in many ways, the yen's rise simply reflects that it is the anti-dollar and anti-euro among G3 currencies in a world where the developed world is struggling after the financial crisis but emerging markets are still thriving.
