Falling Japanese Yen Raises Potential for Broader Market Troubles


Traders around the world are watching the rise and fall of the yen not only to follow the Japanese markets, but also to gauge the mood of investors globally. Usually, when the markets recover, the yen tends to weaken against other currencies. When markets become turbulent, the yen tends to gain ground.

This dynamic was upset this spring.

The yen has fallen 12% against the dollar in 2022, even as the Russian-Ukrainian war dragged global stocks down. Its fall was so steep that it ranks as the worst performing currency this year out of 41 tracked by the Wall Street Journal, worse than the Russian ruble or the Turkish lira.

If the yen were a smaller currency, its decline might matter less to financial markets. But the yen is key to global finance, ranking as the third most traded currency in the world. Its rapid descent is expected to affect not only Japan, but also something seemingly far removed from the country: the $23 trillion US Treasuries market.

The Federal Reserve is set to begin winding down its massive bond-buying program as early as next month. The central bank is counting on investors like Japanese institutions – the biggest foreign buyers of US Treasuries – to step in and help absorb the increased supply of Treasuries in the market.

But the rout of the yen could reduce Japanese demand for Treasuries. Indeed, as the yen weakens, Japanese investors with dollar-denominated assets will have to pay more to hedge against the risk that currency fluctuations will reduce their returns.

In theory, relatively generous US yields should make Treasuries still attractive to Japanese investors. The 10-year US Treasury yields 2.905%; the Japanese 10-year government bond has a relatively paltry yield of 0.25%.

But hedging has become so expensive that the extra return a Japanese investor would get by holding treasury bills instead of Japanese government bonds has all but disappeared. After factoring in the cost of buying currency protection, the difference between the 10-year Treasury yield and the 10-year Japanese government bond yield is only 0.2 basis points. percentage, based on Goldman Sachs Group Inc. analysis using 12-month rolling hedges.

Due to “fear of the unraveling of the weak Japanese yen and expensive US equities”, Japanese institutions such as insurance companies are likely to focus their portfolios more on very long-term Japanese government bonds rather than on U.S. assets, Daisuke Karakama, chief market economist at Mizuho Bank, said in emailed comments.

Japanese investors who decide to stay in the Treasuries market could circumvent higher hedging costs by foregoing currency fluctuation protection, said Ugo Lancioni, head of global currency at Neuberger Berman.

But this carries its own risk. If the yen were to rally sharply against the dollar, “your yield advantage could completely erode within days,” Lancioni said. Traders betting on sustained yen weakness were burned by the rapid and violent unwinding of that bet during the Asian financial crisis. in 1998, as well as the great financial crisis of 2008.

The data shows that Japanese investors have reduced their holdings of foreign bonds. They have been net sellers of foreign bonds for almost a month since November, according to Japan’s finance ministry, selling a net amount of 2.36 trillion yen ($18.4 billion) of foreign bonds last month.

A more pronounced decline in bond purchases by Japanese investors would come at a particularly inopportune time for their US counterparts. Bond investors have already suffered heavy losses this year.

There is also the danger that the sale of US bonds will spill over into other markets, which investors have seen happen in the first months of 2021. Japanese banks, insurers and other institutions have sold tens of billions of dollars of US bonds before the end of their fiscal year. year, exacerbating a sharp rise in bond yields, especially during Asian trading hours. US stocks fell.

Many blamed the fall in equities on rapidly rising bond yields. Higher rates reduce the premium investors get by holding riskier assets relative to Treasuries, making equities less attractive.

Ultimately, stocks rallied quickly after the 2021 episode, posting double-digit percentage gains for the year. But some investors see brewing potential for another pullback.

“If we get another round of bond sales, that will likely challenge stocks more,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.

There is a chance that the decline in the yen will reverse before investors see broader ripples in the market. Speculators who have had their fill of bets on the fall of the yen could abruptly unwind their positions, causing the yen to strengthen rapidly, not only against the dollar, but also against other currencies against which the yen is heavily traded, such as the Brazilian real and the Australian dollar.

But so far, there are few indications of such a move.

Hedge funds are still betting heavily on a further decline in the yen, with net positions against the yen recently hitting their highest level in more than three years, according to recent data from the Commodity Futures Trading Commission.

“I don’t see any force that’s going to stop it at this point unless Japan changes tack,” said Mark Grant, chief global strategist at Colliers Securities.

The other potential trigger for a reversal of the yen: a more brutal intervention by Japan. The Bank of Japan could consider raising interest rates sooner than expected, or the Ministry of Finance could intervene directly in the foreign exchange markets.

Still, some investors are skeptical of the Japanese authorities’ intervention.

Inflation has not been high enough in Japan for the Bank of Japan to necessarily justify raising interest rates, said Idanna Appio, portfolio manager at First Eagle Investment Management.

“Maybe if the yen were to deteriorate significantly from here or if there was political pressure from other countries like the United States saying that Japan was trying to gain an advantage, they would intervene. But I don’t see that happening,” Ms Appio said. mentioned.

For now, some investors are waiting on the sidelines, rather than trying to time bets on the yen’s moves.

“It’s getting to an absurdly cheap level,” Peter Kinsella, global head of currency strategy at Swiss private bank UBP, said of the currency.

Mr Kinsella had been betting on the fall of the yen against the dollar until a few weeks ago when he unwound the trade because he thought it had gone too far. If the yen rises above around 132 against the dollar, he said he would consider betting on its rise.

This story was published from a news agency feed with no text edits

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