USDJPY has not strayed far from the ¥95 to ¥100 range for many months, so the fact it has broken up through the top end of that boundary for the first time since the start of September is catching the attention of investors.
It raises the question of whether USDJPY, after consolidating in a narrowing range since May, might be showing signs of resuming the rally that started this time one year ago.
The yen plunged more than 25% against the dollar between November 2012 and May 2013 as newly elected Japanese prime minister Shinzo Abe pledged to fight deflation and the overvaluation of the yen.
That culminated in the Bank of Japan (BoJ) announcing aggressive monetary expansion plans – known as QQE – in April that helped maintain the downward pressure on the yen. However, that momentum faded as investors looked for further signs of the success of Abenomics as an impetus to sell the Japanese currency.
The latest sell-off in the yen has sparked some speculation it might be the start of a trend related to the reform of Japan’s public pension funds.
They have been under scrutiny since a Japanese government committee was set up in July to review how the industry operates. That committee’s final report is due this week.
Yen bears will be hoping the committee will recommend a more risk-seeking attitude from the industry, which could trigger a move out of JGBs and into equities and foreign bonds.
GPIF, the world’s biggest pension fund with $1.2 trillion under management, has been the focus of attention. As the chart below shows, even a small shift in allocation could be severely detrimental to the yen.
| Sheer size of GPIF assets could have effect on market |
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Hans Redeker, head of global FX strategy at Morgan Stanley, believes the shift might herald the start of a renewed weakening trend in the yen, irrespective of international investor scepticism towards Abenomics.
That trend, he says, will be triggered by increasing Japanese investor confidence and the new reform agenda for pension funds.
“Such an agenda is likely to see market expectations increase for a portfolio allocation away from JGBs towards higher-risk assets, including equities and overseas assets, which will likely put the yen under pressure,” says Redeker.
He says, with USDJPY established above ¥100, he expects the way to open towards ¥101.55 and then the ¥103 area.
Furthermore, Redeker notes market positioning is unlikely to hamper any rise in USDJPY. Indeed, Morgan Stanley’s FX positioning tracker reveals bearish positioning in the dollar is at its highest level for a year.
“There remains plenty of scope for the dollar to move higher from a position adjustment point of view,” says Redeker.
However, not all are convinced.
Gareth Berry, strategist at UBS, warns against expecting any pension-related outflows any time soon, despite the release of this week’s report.
“It could take until 2015 before a sizeable asset-allocation shift takes place, if at all,” he says.
Indeed, attempting to explain the sharp rise in USDJPY witnessed during the past week as anything other than a reflection of the strength seen in Japanese equities – and their negative correlation to the currency – is difficult, according to John Normand, head of FX strategy at JPMorgan.
In other words, he believes, the currency move has not been triggered by a change in behaviour among Japanese investors.
Normand says USDJPY has faced some Japan-specific constraints since the spring.
“The biggest is the lack of Japanese interest in foreign assets, much less the unhedged ones which would move exchange rates,” he says.
Normand says when the BoJ announced QQE in April, he, like many others, expected Japan’s great asset rotation to run from cash and JGBs towards foreign bonds.
In the event, however, surging rate volatility globally – triggered by Japan’s ambitious inflation target, plus talk of tapering from the Federal Reserve – induced Japanese investors to sell foreign bonds.
| Japanese investors have only been buying foreign bonds since September |
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As the chart above shows, those investors did not return to those markets until September.
“Even then, the majority of those flows appear to be from banks who would hedge currency exposure until US cash rates rise,” says Normand.
“And while Japan has posted six consecutive weeks of outflows into foreign bond markets, the pace has not accelerated just because US rates bottomed out two weeks ago.”
Furthermore, Japanese retail investors have not been selling yen, judging by foreign currency Toshin investment trust and mutual fund flows, or by changes in retail FX margin trading positions.
| Japanese retail is not selling yen through margin trading accounts |
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“Thus there is still no sign that Japanese investment behaviour has changed in a way which is meaningful for currencies,” says Normand.
Steve Barrow, head of FX strategy at Standard Bank, believes the recent rise in USDJPY is associated with the surge in Japanese stock prices in the past week and a rise in US bond yields relative to JGBs.
“The problem, from our perspective, is we’ve seen these things before and the rally in USDJPY has proved short-lived,” he says.
According to Barrow, it is real – inflation adjusted – rates that are crucial for currencies, not nominal ones. As can be seen in the chart below, there has not been much movement in the past couple of months, as the effect of the sharp rise in Japanese inflation expectations triggered by the BoJ’s aggressive April monetary easing has worn off.
| Waiting for the next surge in USDJPY |
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Barrow believes if Japanese policymakers want to see USDJPY embark on a rise similar to that witnessed between November 2012 and May, Japanese inflation expectations need to rise much further. That, he says, can only be engineered through another dose of aggressive monetary easing from the BoJ.
With BoJ easing unlikely in the very near term, that suggests the current rally in USDJPY might fizzle out.
Indeed, Barrow believes it will only be when the looming Japanese sales tax in April gives the central bank an excuse to loosen monetary policy further that the yen will move decisively lower.
“The next significant rally in USDJPY will come when the BoJ steps on the monetary gas again, and that seems likely next spring,” he says.
“So while we retain the belief that USDJPY should target ¥120 over the next year or so, the next step upwards towards this level seems unlikely for a few months.”
Despite the recent rally, USDJPY might find itself stuck on the launch pad as the year draws to close.