LONDON, April 27 (Reuters) – Investors are positioning themselves for regime change in global markets as the Bank of Japan moves closer to abandoning policies that have weighed the yen down for decades, luring Japanese money home.
By flooding its financial system with cheap cash and keeping interest rates below zero for years, the BOJ turned its currency into the ideal financing vehicle, sending trillions of dollars of Japanese cash abroad in search of better returns.
It is now the final hurdle in the global race to hike interest rates, but with Japanese inflation at multi-decade highs, the yen has steadily strengthened.
That means portfolio managers will need to factor a stronger yen into global stock picking in a way they haven’t in years, with some even anticipating mergers and acquisitions as the Japanese market picks up.
“The trigger for the repricing of Japanese markets is higher interest rates and then a stronger yen. It’s a market that has been undervalued for years and is a value trap,” said Frederic Leroux, Carmignac’s head of cross-asset.
Foreign Holdings of Japanese Investors Source: Bank of Japan/Deutsche Bank
The yen is up more than 11% from 30-year lows against the dollar hit last October and around 9% from 8-year lows hit against the Australian currency last year.
Kazuo Ueda, concluding his first two-day meeting as BOJ chief on Friday, has stressed the need for ultra-loose monetary policy but also signaled the possibility of raising interest rates to tame inflation.
Others expected more money to exit major bond markets, which have long offered far better yields than Japanese counterparts, as expectations for policy change mount.
“We are on the verge of an asset repatriation back to Japan and the numbers are really quite large,” said Sam Perry, senior investment manager at Pictet Asset Management. “This reversal could actually be quite dramatic.”
According to calculations by Deutsche Bank, Japan’s insurers and pension funds alone hold 1.84 trillion dollars in foreign assets, more than the South Korean economy.
Japanese investors are the largest foreign holders of US Treasuries.
With Japanese non-energy inflation at its highest level in four decades, the BoJ may consider ending its yield curve control (YCC) policy – through which it keeps long-term interest rates extremely low through the purchase of Japanese government bonds (JGBs) – at some point Year.
Some market watchers believe it could even happen this week.
“Policy normalization could turn back the clock for Japanese investors,” Deutsche Bank strategists said in a statement. “This is a regime change that comes only once in a generation.”
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LONG YEN? TRY STOCKS
Citi strategists have set a target for the Japanese yen of 125 per dollar, compared to 134 now, but also expect the currency to continue strengthening from that target over time.
The prospects of a spending spree in Japan, where decades of deflation have forced people to save money and wait for products to get cheaper, are raising interest in a long-neglected stock market.
Carmignac’s Leroux said that due to Japan’s aging population and labor shortages, the recent comeback of inflation could boost wages and hence consumption.
A stronger yen would increase the power of households to buy imported goods, he added, all of which could potentially boost the economy.
Tokyo’s Nikkei (.N225) has traded at a discount to the S&P 500 (.SPX) for the past nine years. Its price-to-earnings ratio now stands at 14.7, compared to 22.7 for the US index.
Carmignac, like many global investors, has maintained an underweight stance on Japanese equities but, Leroux said, is attempting to move to neutral.
DOMINO EFFECT
Japan is a global heavyweight in the bond market. Its yield-hungry investors own nearly 6% of Australia’s bonds and 4.1% of France’s bonds, according to Deutsche Bank. Japanese investors also hold more than $1 trillion worth of U.S. Treasuries.
But when a big market is hit, it can impact smaller ones.
“Without that liquidity, you run the risk of the market putting pressure on some of its weaker parts, such as peripheral eurozone bonds,” said Wouter Sturkenboom, chief investment strategist for EMEA at Northern Trust Asset Management.
Still, Sturkenboom said he expects only a gradual change in YCC policy.
Japanese investors dumped foreign bonds in 2022. And while that trend reversed in early 2023, Deutsche Bank estimates domestic investors are likely to buy another $600 billion worth of domestic bonds once the BoJ backs out of its massive JGB purchases that have been depressing yields.
Low Japanese interest rates have made the yen the funding currency of choice for carry trades, where traders typically borrow a low-yielding currency and then sell the proceeds and invest in assets denominated in a higher-yielding currency.
Analysts say the yen is still the ideal carry trade currency, but research from Bank of America shows that the market hasn’t actually sold the yen to fund carry trades in a while.
“Our discussions with clients also suggest that the market is (for now) at least neutral on the yen,” the bank said in a statement.
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Reporting by Naomi Rovnick, Amanda Cooper and Harry Robertson; Edited by Dhara Ransinghe and Clarence Fernandez
Our standards: The Thomson Reuters Trust Principles.
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