Yen bears may emerge from hibernation in April
Like Hokkaido’s Higuma Bears, yen bears may be poised to come out of hibernation. But the latter won’t be driven by the advent of spring in Japan but by the beginning of the new Japanese financial year on April 1, which could be accompanied by new capital outflows out of the yen.
By that same token, investors should be wary of over-interpreting price action in the last days of March which, to a large extent, may merely reflect Japanese financial year-end balance sheet window dressing. Just because the yen comes home doesn’t mean it will stay there once the new financial year begins.
Additionally, Japan’s investors will have fresh money to put to work in the new financial year and that too may mean yen-negative offshore investment.
In the fixed income sphere, Japanese investors may rationally conclude their best options for earning material yields lie offshore, with the Bank of Japan (BOJ) seemingly determined to stick to its current monetary policy settings regardless of anything happening elsewhere.
“There is no reason to reduce the level of monetary accommodation in light of current economic and price developments,” BOJ governor Haruhiko Kuroda said on Friday. “I don’t think we need to raise our interest-rate targets now. It’s unclear whether inflation will hit our 2 per cent target before my term ends” in April 2018.
“The [BOJ] will not raise the target level of the long-term interest rates just because of a rise in such rates in other countries,” he added.
Mitsubishi UFJ Morgan Stanley Securities (MUMSS), writing on Friday, felt that while the path of the dollar/yen exchange rate is hard to predict, it may “remain in a narrow range over the near term” but that the yen is unlikely “to appreciate much further.”
As for the yen’s recent rise, or more specifically the dollar’s recent pullback, MUMSS focuses not on any factors related to the imminent end of the Japanese financial year but instead ascribes the moves to the unwinding of short US Treasury positions in the wake of the Fed’s March 15 rate increase.
MUMSS notes that “in the Chicago futures market, speculative (non-commercial) positions on 10-yr US Treasuries were net short by a margin of 409,000 contracts (as of March 3)” but that this “fell to a net short of 194,000 contracts on March 17, as some investors likely changed their view after confirming that the Fed will not pick up its pace of monetary tightening, despite deciding to raise rates in the March FOMC meeting.”
Nevertheless, MUMSS believes that “the Fed is likely to maintain its gradual tightening policy, in light of prices and employment conditions in the US, meaning that long-term rates are unlikely to see another phase of persistent decline” and that “this in turn would limit downside for the dollar.”
Of course that doesn’t mean the dollar will rise versus the yen but a catalyst for such a move could be if financial conditions in the United States become somewhat tighter even while the Fed stays on its current measured and avowedly data-dependent course.
A fall in deposits in the US Treasury’s account with the Federal Reserve may point to such a tightening of financial conditions.
The first business day of the US fiscal year in 2016 fell on October 3, and on that date the US Treasury had a closing balance of US$ 339.8 billion in its account at the Federal Reserve. At close of business on February 13, 2017, the day President Trump’s nominee Steven Mnuchin was confirmed as Treasury Secretary, the balance had fallen to US$ 319.6 billion.
By last Thursday, the balance had dropped to just US$ 68.8 billion. It’s hard not to conclude that the US Treasury has been using withdrawals from the account as an alternative to other ways of raising money, such as borrowing.
That drawdown must have fed into the US economy either through direct government spending or through the freeing up of capital for investment elsewhere that would have ordinarily flowed into government borrowing. All this would have lent itself to looser financial conditions.
But with the account now largely drawn upon, financial conditions in the United States may tighten again as the government will still need to raise money to meet its obligations.
The attraction to Japan’s investors of shifting out of yen into dollars to place in US paper might be renewed. The beginning of Japan’s financial year in April may see the yen bears emerge from hibernation.