The yen’s surprise decline makes more sense in the context of the country’s pension funds shifting an increasing portion of their assets abroad
By Mike Bird
One-time events in Japan haven’t stopped rapid yen appreciation in the past. / Photo: Toru Hanai/Bloomberg News .
The yen has slumped this week, perplexing investors who associate periods of uncertainty and stress with a rising Japanese currency.
The pattern makes more sense in the context of falling hedging costs and the country’s gargantuan institutional investment firms, which are increasingly moving assets abroad to escape low-yield Japan.
The dollar moved around 1.9% higher in the two sessions to Thursday, reaching almost 112 to the yen, the largest two-day shift in almost 2½ years.
Analysts at Rabobank and elsewhere had wondered if the yen’s diminishing role as a haven was because Japan’s economy is itself at risk of being further upended by the coronavirus outbreak.
A survey of the Japanese manufacturing sector released Friday showed the sharpest reduction in activity in seven years during the initial weeks of February.
But one-time events in Japan haven’t stopped rapid yen appreciation in the past: The yen rose almost 6% during the 2011 nuclear disaster at Fukushima.
The yen has risen when North Korea’s missiles have flown over Japan. The currency market isn’t always a place of relentless logic.
Data released by the Ministry of Finance might indicate what is going on.
In January, the trust accounts that act for Japanese pension funds booked over 2 trillion yen ($17.94 billion) in net purchases on long-term foreign bonds. That isn’t just the highest amount on record, but 62% higher than the next highest. It is equivalent to around five months of purchases based on the 2017-19 average.
Hedging costs go some way to explain the shift. Japanese hedging costs have been high for several years: In late 2018, a one-year dollar-yen forward contract effectively cost a Japanese investor 3.4% relative to the spot Price.
That hedging cost has ticked almost continually lower as U.S. bond yields declined, falling to around 1.9% this month.
Periods in which hedging costs are falling, more than the actual level of the costs, tend to be correlated with large-scale purchases of U.S. government bonds.
Indeed, in the three months to December—the last for which we have data—Japanese investors bought more U.S. government and agency bonds on net than at any point over the past 3½ years, according to the Treasury Department.
But some purchases aren’t likely to be hedged at all. Rule changes late last year allowed the ¥168.99 trillion Government Pension Investment Fund to class fully hedged foreign bonds as domestic debt. That allows for more unhedged purchases, which would further fuel the yen.
The failure of the yen to appreciate in a risk-off scenario can also become self-fulfilling. If it is no longer received wisdom that Japanese investors will repatriate foreign profits and pivot back home in times of stress, markets will no longer treat the yen as a haven.
Either way, traders who expect the yen to rally in risk-off periods may find themselves in an unenviable position, fighting flows from the country’s pension giants’ deep pockets.
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