Yen: Between Repatriation and Depreciation
Japan's much-awaited anti-deflation package--unveiled in the last week of February-- missed the mark as far as markets were concerned. The package involves two phases: The first will contain measures to stabilize stock prices and a call for additional monetary easing from the Bank of Japan. The second phase, postponed until after March 31 (the end of the fiscal year) will tackle the main issue of tax reforms and the elimination of bad debt loans. Injections of public funds into banks will only be implemented in case of severe financial crisis. This begs the question as to what really constitutes crisis in Japanese terms. The whole package is structured to work in coordination between the government and the Bank of Japan. The package consists of two parts instead of one due to Diet's (the Japanese parliament's) current debate of the budget draft for the coming fiscal year and Koizumi's pledge to keep the 30 trillion yen of bond issuance for the present year. But markets' expectations were so low that the Japanese government didn't disappoint its critics. Even the Bank of Japan's latest decision to further ease monetary policy had very little effect on sentiment. Overall pessimism with Japan's reform inertia is likely to increase rapidly and push the Japanese currency lower over the medium term. The only obstacle has been seasonal repatriation flows, which occur when Japanese investors sell their foreign-based assets and convert the proceeds into yen to boost balance sheets ahead of the end of half-year and full year book closings in September and March respectively. While repatriation forces could drag the dollar down to the 131.00-50 region, a waning in these operations in late March may pave the way for a resumption in yen outflows. Thus, USD/JPY could target the 138-140 once the 135.00/20 major resistance band is broken.
Repatriation ReversalJapanese repatriation stands on its head the normal pace of outward investment during the months leading up to the fiscal half year-end in September and fiscal year-end in March. But after these periods, outward investment resumes, putting yen under pressure. Following the half-year end in September 2001, Japanese net investor flows turned sharply outward in October putting the yen under pressure as it fell from around 119.50 to 123.50 against the dollar. Japanese were large buyers of foreign bonds and equities at this time, totaling 5.5 trillion yen -- The largest increase in over 3 years of outward investment. Consequently, Japanese net portfolio flows are likely to turn negative again in April given the weakness in Japanese stocks and the risk associated with the Japanese government bond bubble. Reversal of repatriation flows should then propel USD/JPY higher.
Stocks Still a FactorJapanese repatriation flows in the January-February period this year were double those seen in the previous two years and a major reason the yen was able to fend off further losses. Short yen positions fell back in January as the Japanese brought an enormous 3.3 trillion yen back home. Banks whose capital bases are being undermined by both the losses on their equity portfolios and non-performing loans led the majority of repatriation this year. Recall that the Nikkei fell 30% in domestic terms since last March and banks have had to repair those losses by bringing home overseas assets. The strong repatriation was partly a result of Japan's weak yen policy, which drove investors en masse out of Japanese assets. As a result, in February the Japanese government shied away from its weak yen policy and helped put a floor under asset prices by using the Resolution and Collection Corporation to buy up non-performing loans. Regulators have also tightened rules on the short-selling of equities which will stem sharp share price declines. The government hopes this will keep the Nikkei at or above 10,000, which would avoid the need for an infusion of taxpayers' money to help rid banks of non-performing loans. The government dislikes the idea of another public injection, as it would amount to an admonition of failure and be politically unappealing. Therefore, with an artificial floor under stock prices, firms are unlikely to need to bring home more overseas assets ahead of the fiscal year end close on March 31.
Traders To Rebuild Short Yen PositionsThe activity in currency futures also shows traders' assessment for a currency in the short to medium term. The chart below shows that speculators have been net sellers of yen futures contracts against the dollar since December 2001, betting on no improvement in Japan's fundamentals. This is rather notable since traders are usually net buyers of yen during the 4-5 week period preceding the end of book closings in September 30 and March 31 each year. Looking at the period between August and September 2001, one can see that the futures market was a net buyer of yen contracts in contrast to the 4-5 week period prior to March 31st of this year. In 2002, speculative positions have remained largely in favor of the dollar against the yen (net short in yen). But the reduction of these short positions (increase in long yen positions) in January into February may suggest that traders are positoning themselves to short the yen again. And the fact that speculative positions have remained yen negative during a period where the spot USD/JPY rate was range-bound (132-134.50), indicates that the dynamics are still slanted towards expecting additional weakness in the yen versus the dollar. Considering the weak economic conditions in Japan, coupled with the trend in Japanese stocks and bonds' flow as well as the dynamics of speculator's positions in the futures market, it is likely that the Japanese currency will face further pressure into Q2 2002.
