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JGB yields in white, USDJPY in orange

Japanese private/public investors slowly positioning for weaker JPY in FY10 –> strong dip buying bids near 89.50 Lifer IPO demand (~¥400bn) may temporarily help JPY, but HIA past its peak, no major exporter offers until 91.50 Weak land prices, department store sales will sustain BoJ easing bias; watch BoJ minutes after Monday’s holiday Nikkei up 0.8%, JGB futures up 8 sen – value still lies in superlongs; supply digested, month end approaching

The world will not suddenly change with the beginning of the new fiscal year in Japan on 1 April, but we do believe it will coincide with the start of a more sustained JPY retreat. Japanese dip buying has strengthened and a number of conditions are slowly but surely falling into place that suggest weaker JPY bets will finally pay bigger dividends – again, our end-FY10 targets remain 100 USD/JPY and 150 EUR/JPY. Consider the following:

  • Institutional and corporate repatriation flows ahead of the 31 March book closing (a key tenet of our call for a bullish JPY correction this quarter, which has been more mild than we expected) have peaked. This should dilute upside resistance primarily for USD/JPY and EUR/JPY. HIA-type activity in particular will slow markedly from next month.
  • Leveraged carry trades by foreign investors will re-enter the JPY equation in a bigger way. To be sure, such trades are notoriously difficult to detect or quantify in a timely manner via the hard data, but we would point to the trend change in the short-term repo component of the financial account in Japan’s balance of payments data. One can see in the chart below that the short-term repo balance posted its first net outflow on a 12mms basis since November 2007. Recall that the net outflow here peaked in Q107, when leveraged carry trades by foreigners were well established and JPY was a lot weaker – around 122 USD/JPY, 160 EUR/JPY, 242 GBP/JPY, 105 CAD/JPY and 96 AUD/JPY.
  • While it would be dangerous to expect a sudden tidal wave of Japanese institutional money to head overseas from next month, the high degree of FX risk aversion witnessed during FY09 promises to abate. Bear in mind that JPY-denominated ‘foreign’ bonds (including Samurai) have accounted for over 40% of the overall Japanese take in the fiscal year to date, eclipsing all other currency buckets. Come FY10, look for the home currency bias to gradually fade, initially via a reduction in hedge ratios at lifers alongside more aggressive dip buying at progressively higher USD/JPY and cross/JPY levels from longer-term strategic players betting on wider actual/implied policy rate gaps vs Japan. FY10 investment plans of the major lifers include USD/JPY assumptions above 100 and clear intentions to buy EUR/JPY on any correction towards 120. While GPIF has not changed its basic asset allocation plan, we believe Japan Post’s unhedged UST investment in Q409 is a harbinger of a more accommodating attitude towards FX risk in the new fiscal year. This does not mean an exodus from JGBs, which will remain the core investment for domestic institutions and offer the best ‘insulation’ in global portfolios for those assuming a rising yield environment globally in FY10 as we are.
  • One cannot overlook individual investors, who are sitting on a ¥790trn pile of currency and deposits earning virtually zero. This month’s toshin demand has been rather patchy (with an initial take-up ratio of 13% vs 8% in February), but retail activity is more likely to rise than slow in coming months. Flows into investment trusts are highly correlated with the unemployment rate and consumer confidence – the former peaked at 5.6% in July 2009 and the latter has recovered from its December 2008 trough (26.7 based on the ESRI’s headline index). While currency selection has become more targeted, the strong demand for BRL even in the face of still-difficult labour market conditions reinforces our view that households are still willing and able to look at higher-yielding options beyond the domestic market. Margin traders are certainly not shying away from FX risk.