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Written by Vidya Ranganathan
SINGAPORE (Reuters) – Even as the Bank of Japan prepares for a pivotal change in monetary policy, analysts say Japanese investors are losing about $3 trillion in yen they have parked in global bond markets and yen trading. They say more needs to be done to make a real shift.
Japanese investors have poured trillions of yen overseas under the Bank of Japan’s decades-long effort to end deflation, hoping to get better than near-zero returns at home.
The Bank of Japan may change its policy as soon as this week. Rising wages and other business activity suggest the economic stagnation is over, meaning there is little need for the Bank of Japan to continue to keep short-term interest rates negative.
Expectations for improved growth have attracted foreign funds to Japanese stocks, and yen bond yields have risen.
Attention is also focused on the $2.4 trillion in foreign debt held by Japan’s life insurance companies, pension funds, banks and trust companies, and how much of that investment flow will return to Japan.
But because these holdings give yen investors more than a 5% return, analysts say investors are unlikely to react even if the Bank of Japan raises interest rates by 10 or 20 basis points.
“Honestly, I don’t think it will have a big impact on flows,” said Alex Etra, senior strategist at analytics firm Exante Data.
According to Ministry of Finance data, Japan’s total external portfolio investment was 628.45 trillion yen ($4.2 trillion) as of the end of December, with more than half of it in interest rate-sensitive debt assets, most of which are long-term. It is.
The Bank of Japan launched quantitative and qualitative easing (QQE) in May 2013. From that time to the present, Japan’s external bond investments amounted to approximately 89 trillion yen, nearly 60% of which belonged to huge pension funds such as the Japan Pension Reserve Management Agency and the Japan Pension Reserve Management Agency. . GPIF.
According to Exante’s Etra, Japanese pension funds do not routinely hedge currency risks with foreign bond investments, and the returns on foreign bonds are attractive, especially when converted to yen.
hedging is a pain
“I don’t really buy that repatriation story,” said Gareth Berry, currency and rates strategist at Macquarie Bank.
“If you look at the numbers over the last 20 years, repatriation was actually very low even during the global financial crisis,” he said, referring to the 2008 global financial crisis.
In contrast to pension funds, large Japanese banks and life insurance companies tend to hedge their foreign bond holdings to reduce exposure to deposits and other yen liabilities.
Flow data shows that this group of investors, which includes Japan Post Bank and cooperative bank Norinchukin Bank, is gradually reducing their foreign bond holdings from 2022 onwards.
Nomura strategist Hitoshi Mogi said investors such as insurance companies would repatriate their overseas investments only if the yield on domestic Japanese government bonds (JGBs) was sufficient.
He expects a full-scale repatriation to occur only if the 20-year Treasury yield reaches 2%, which would mean a rise in long-term Treasury yields by about 50 basis points. Nomura expects the Bank of Japan to raise the overnight interest rate to 0.25% by October.
“In our view, the potential repatriation caused by the end of YCC is likely to be up to around 45 trillion yen.We also expect Japanese life insurance companies to be potential main players in repatriation. “There is,” Mogi said.
Furthermore, if short-term yen interest rates rise at the same time as the Fed begins to cut interest rates, hedging costs will fall, making currency-hedged US Treasury investments even more attractive.
Japan Post Bank, Norinchukin Bank and GPIF did not immediately respond to Reuters’ requests for comment on the investment plans.
carry and volatility
The impact that the Bank of Japan’s lifting of negative interest rates will have on the opaque world of currency carry trading will depend not only on the initial interest rate hike, but also on the signals the Bank sends regarding the trajectory of interest rates.
For decades, the yen has been the financing currency of choice for transactions in which investors borrow zero-cost yen and exchange it for high-yield dollars. Although these short-term trades can yield large profits, they are highly susceptible to small fluctuations in interest rates and exchange rates.
A three-month carry trade between the dollar and the yen had an annual return of 7% in December, but now it’s only 5% as both the yen and Japanese yields have risen.
There is also no easy way to estimate the value of such transactions. The cumulative total of short-term loans to foreigners in Japan is approximately $500 billion, which may serve as a rough guide to the carry trade balance.
If the market starts pricing in higher short- and intermediate-term yields, the “carry” on these trades could shrink quickly.
James Malcolm, a currency strategist at UBS in London, said a roughly 10 basis point change in the interest rate spread between the dollar and the yen has helped push the dollar-yen rate up about 1% over the past two to three years.
“If a large carry trade is currently accumulating, the risk is that a small change will cause a capitulation and FX will move even more by generating its own dynamics.”
(1 dollar = 149.0200 yen)
(Additional reporting by Lei Wee and Tom Westbrook in Singapore; Ritsuko Shimizu and Makiko Yamazaki in Tokyo; graphics by Paturaja Murugaboopathy; editing by Lincoln Feast.)
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