The Yen Really Should Be Stronger

This time it could be different; the Yen's failure to rally is trying to send us a powerful message.

If the Yen was still perceived as a safe-haven, as it has been for at least the last two decades, then USD/JPY really should be at least below 100, if not 95, but last week USD/JPY hit 109.46-its highest level since Aug. 2008, just before the Lehman bankruptcy triggered massive safe-haven flows into the Yen, which were subsequently augmented by Eurozone crisis fears, taking USD/JPY to a low of just above 75.00 in Oct. 2011. Even the deathbed Euro is within 3 or 4% of its highs against the Yen for the last five years.

This despite Russia's expansionist adventures, renewed 'Holy War' military intervention in the Middle East from the western Coalition, and simmering tensions between China and Japan in the North and South China Seas.

What has triggered this fall from grace?

Sure, the USD is strong across the board, but we have witnessed many occasions in the past when the Yen was viewed as an infinitely preferable safe-haven, e.g. the Autumn of 2008. This recent move higher in USD-JPY has been driven partly by across-the-board USD strength, as it sinks in that US QE really is coming to an end, and that the Fed may even raise rates next year, but this is not the real story behind Yen weakness.

Firstly, in contrast to the Fed's QE taper, the BOJ is poised to prolong its own QE programme; the consumption tax hike in April of this year took a much greater toll on the economy than it had expected, with real GDP shrinking by 7.1% q.o.q. annualised in Q2, (only partly due to a pre-tax rush to the shops in Q1), and at its meeting on 31 Oct., the BOJ's Outlook Report must surely reduce its 2014 growth forecast to, say, 0.5% from 1.0%. Another factor keeping Kuroda, the most activist BOJ Governor we have seen in many decades, on alert is that, although nominal wages and CPI are now both positive for the first time in many years, this actually means that real wages have not risen appreciably.

As Takehiro Sato, a BOJ policy board member, recently put it to Bloomberg, the more government debt a central bank buys, the greater the appearance of "fiscal dominance" - where monetary policy essentially becomes a ruse to keep the state solvent, "We are buying tonnes of JGBs; we are monopolising the market," says Mr Sato. We are witnessing deficit financing, plain and simple.

The second major event of late has been the appointment of Yasuhisa Shiozaki as health minister, with responsibility for implementation of radical changes to the investment mandate of Japan's public pension fund, the Government Pension Investment Fund (GPIF), the world's largest with $1.25 trillion (736 billion pounds), in its coffers. Shiozaki, who previously served as deputy policy chief for Prime Minister Abe's Liberal Democratic Party, has been a vigorous proponent of reducing GPIF's reliance on domestic bonds, looking to equities and overseas bonds to increase returns, taking the fund's target for domestic bond investments to 40% from 60%. Masahiro Nishikawa at Goldman Sachs Japan expects that public pension fund rebalancing could result in yen-selling pressure of at least 11 trillion yen.

This does not even include Japan's massive private pension savings; Japanese total pension AUM (including private) is $2.6tn. Then there are also massive savings residing in accounts at institutions such as Japan Post/Kampo. Japan Post Bank's foreign currency-denominated assets rose 6.8 trillion yen ($65.39 billion) over a year to some 25 trillion yen as of the end of June, while Japan Post Insurance's holdings of foreign investments increased 700 billion yen to around 1.6 trillion yen.

Since the start of the new fiscal year on 1 April, Japanese institutional investors have been net buyers of foreign bonds in 15 of 22 weeks. More recently, they have been net buyers of foreign bonds in four of the last five weeks.

There are those who feel the new-found close coordination between Government and the BOJ, enshrined in the so-called 'Three Arrows' strategy to boost the economy, is altogether too close. Member of Parliament Takeshi Fujimaki is warning that Japan's debt problem is out of control, and predicts that deficit financing by the BOJ will ultimately lead to a collapse in Japanese government bonds, (JGB's), sending yields through the roof and USD/JPY plunging to 1,000.

The strategy of shorting JGB's has come to be known as the Death Trade, reflecting of the piles of 'bodies' littering the streets of Mayfair; the remains of those hedge fund traders who have adopted this strategy over the last ten years, only to see ten-year yields stay stubbornly close to 0.5%.

This time it could be different; the Yen's failure to rally is trying to send us a powerful message.

Before You Go