Japanese Yen is a sleeping giant scattered all across the globe, from the United States to Australia. Once it awakens and decides to move back to its home ground, things won’t be good for the capital markets.
The global market for bonds is standing at a cliff awaiting the policy change decisions of the Bank of Japan (BoJ), which is anticipated to push Japanese yields north. This makes it pull out trillions of dollars from global markets and locate back to Japan.
The BoJ had negative interest rates for decades, overloading its financial system with cheap cash. This made the Japanese Yen the best-suited currency for funding ventures, and this flushed trillions out of the Japanese economy to global markets for luring returns. But now, the BoJ wants all the money back home.
Global investors who used easily available Yen for churning better returns will now have to tweak their investment portfolio by factoring in an expensive Japanese yen. Investment Banks are assuming a lot of mergers and acquisitions opportunities for them as and when the Japanese market picks up pace.
Frederic Leroux, head of cross-asset at Carmignac, said that the start of revaluation of the Japanese markets would be because of higher interest rates and a stronger Japanese yen. The attractive undervaluation of decades has turned out to be a value trap.
According to data from the Ministry of Finance, the increase in Japanese yields squared off positions in overseas bonds worth ¥21.7 trillion ($166 billion). It was a record sale last seen since 2005. Japanese investors tend to be the largest foreign owners of government treasuries and the largest overseas holders of US Treasuries. Analysts expect a massive selloff in the bond markets of Australia and France if they act as expected.
Kazuo Ueda, the chief of BoJ, emphasised the urgency of implementing an ultra-loose monetary policy but also warned about the talks of increasing rates to curb inflation.
Japanese pension funds and insurers have $1.84 trillion in their foreign assets portfolio, according to the calculation of Deutsche Bank. This figure is even larger than the economy of South Korea.
Market observers expect that the BoJ might end its yield curve control (YCC) policy this week itself. This policy is responsible for maintaining ultra-low interest rates by buying Japanese government bonds (JGBs).
The Ripple Effect
Japan is a heavyweight investor in the global bond market. Its investors hold 6 percent of Australian bonds, 4.1 percent of French bonds, and more than $1 trillion of US Treasuries. It is out of the question if they feel the heat; it will spiral down to other emerging and underdeveloped markets.
Wouter Sturkenboom, chief investment strategist for EMEA at Northern Trust Asset Management, said that in the void created by the absence of liquidity of such scale, the markets would assert pressure on its pain points, like peripheral bonds of the eurozone.
According to estimates of Deutsche Bank, the Japanese investors who sold foreign bonds are assumed to dump $600 billion in the domestic bonds market once the BoJ stops purchasing JGBs, which has kept yields under contraction.
The gameplay of traders is borrowing the low-yield currency, the Japanese Yen, as a result of low-interest rates, then selling and investing it in assets returning a higher yield.
Bank of America showed that for some time, the Japanese Yen had not been sold to carry forward trades despite the analysts saying that the Yen is still the ideal currency for carrying trades.
Effect on Nikkei
Japan’s benchmark index, Nikkei, has been trading at a discount to the S&P 500 for the past nine years. The price-to-earnings ratio stood at 14.7, besides 22.7 of the US Index.
CitiBank strategists are highly bullish on the Japanese Yen. They have told a target for the Yen of 125 per dollar but leave room open on the upside. They are expecting the currency to strengthen further.
Leroux from Carmignac added that the aging population and shortage of young workforce might lead to inflation to improve remuneration and boost individual consumption.
The Japanese stock market has been badly affected by the saving nature of the citizens. But trends seem to change regarding consumer spending. Where people delayed purchases to avail discounts is now witnessing extravagant spending.
The economy could get back on track from decades of deflation with a stronger Japanese yen. A strengthened currency will boost the purchasing power, leading demand for imported products to go up, hence improving the overall economic scenario of the country.