Global Recovery Plus Increased Risk Appetite Equals Weaker Yen
Standard Chartered says the yen's strength may stall at 91.30, which looks like a chartist's call. High Frequency Economics says the yen's strength may reverse because current strength is either speculative or driven by non-price related motives for the purchases, like a yen carry trade reversal.
Japan's economy is expected to decline over 6% this year, while Japan’s tax revenue fell short of the government's forecast in FY2008 by about JPY 2.2 trillion ($23 billion), and could by JPY4~JPY5 trillion short in FY2009 as the government is projecting only a 3%-plus decline. A record JPY13.9 trillion extra budget passed in May, will be mostly funded with debt, bringing new bond sales to an unprecedented JPY44.1 trillion, and total bond sales will surge to JPY130.2 trillion, the highest ever.
Yet JGB (Japanese bond bulls) see 10-year JGB yields at 1.30% by end 2009, versus 1.335% today. JGBs, say the bulls, will benefit from growing inflation and waning loan demand, and Japanese banks are using depositor savings they can't find anybody to loan to to purchase JGBs.
Is demand for JGBs boosting the yen? Not likely. Net portfolio outflows (domestic investor purchase of foreign securities including stocks, bonds and notes) has surpassed foreign buying of Japanese securities by JPY19.52 billion in the first six months of 2009. The net commitment of large speculators by CFTC stats (Commodity Futures Trading Commission) is long, but only about 1/3rd of the prior peak in December 2008-January 2009. The net balance ofinteroffice accounts of foreign banks in Japan, which an October 2007 BOJ IMES (Institute for Monetary and Economic Studies) working paper identified as a major force in the yen carry build-up (and prior to the credit crisis of 2007) is now back to negative, meaning foreign banks are already holding net long positions in Japanese assets and have been for some time.
Foreign exchange futures contracts on the Tokyo Financial Exchange show open interest on all leverage forex contracts doubling from 193,860 contracts in March to 394,150 contracts recently, and USD/JPY contracts surging 2.5-fold from 39,030 contracts to 96,931 contracts since January, but growth in these contracts is a sign of selling, not buying pressure from mainly Japanese retail investors in the yen.
There was however a noticeable 14% reversal in the open interest on USD/JPY in June with talk of the government limiting the amount of leverage that Japanese retail punters could use on margin forex trades. In addition, net portfolio investment flows were inward, not outward in the last week, according to MOF data.
Consequently, we have a problem with the "safe haven" buying explanation given for the yen's recent strength. The yen is not a safe haven from its economic fundamentals, which are horrible and strongly imply increased government debt issuance. Yes, Japan does have a balance of payments surplus but it is shrinking on plunging exports, and some 92% of the demand issued in Japan is owned by the Japanese themselves, making this debt largely self-finance-able. But savings rates are already only 1.8% and could go negative over the next several years while government debt soars to 2X GDP.
We also have a problem with the yen carry trade reversal theory, given the current position of net interoffice accounts of foreign banks in Japan. A more likely short-term explanation is a) repatriation by Japanese companies/overseas portfolio investors and b) a partial unwinding of some leverage retail forex positions. Given a return to confidence in an economic recovery, however, the strong yen move could evaporate fairly quickly as Japanese institutional investors chase more attractive yields overseas and retail forex punters also chase yield overseas.
Labels: Japanese Yen


