Japan Fund Revamp Seen Aiding Frustrated Yen Bears: Currencies

Aug 20, 2014 4:48 am ET

(For a Currencies column daily alert: SALT FXCOL.)

Aug. 20 (Bloomberg) -- Yen bears frustrated by the Bank of Japan’s failure to extend its stimulus program are counting on the world’s largest pension fund to drive the currency lower.

Japan’s Government Pension Investment Fund is likely to buy more local and foreign stocks after a strategy review that may be completed as soon as next month. That would boost investor optimism and weigh on the yen, according to Mitsubishi UFJ Morgan Stanley Securities Co. The correlation between stocks and the dollar-yen exchange rate rose this month to the highest since 2013.

“Anticipation of stock gains on the back of GPIF reform is boosting risk appetite and bearish bets on the yen,” Daisaku Ueno, the chief currency strategist at Mitsubishi UFJ in Tokyo, said yesterday by phone. “GPIF’s new portfolio” may become “the benchmark model for Japan’s investment community.”

The yen has confounded traders who bet on a decline this year, instead gaining versus 12 of its 16 most-traded peers as the BOJ failed to add to its 60 trillion yen ($583 billion) to 70 trillion yen of annual asset purchases. Such stimulus plans tend to weaken a currency by increasing the money supply.

Investors are now pinning their hopes on GPIF, which is awaiting the results of a review into how it allocates $1.23 trillion of funds and faces pressure to take more risks as pension payouts rise for the world’s oldest population.

Predicting Losses

GPIF, which took over from Japan’s old state pension fund in 2006, will lift a cap on domestic equity holdings to 20 percent of its portfolio from 12 percent and raise its limit on foreign assets to 31 percent from 23 percent, analysts surveyed by Bloomberg said in May. Officials may complete the review as early as next month, Japan’s Nikkei newspaper reported in July.

The changes may weaken Japan’s currency by as much as 6 yen per dollar, depending on how and when the revamp takes place and the extent to which other investors follow its lead, Mitsubishi UFJ’s Ueno estimated.

The yen will fall about 2 percent to 105 per dollar by year-end, from 102.92 yesterday in New York, according to the median estimate of more than 50 strategists surveyed by Bloomberg. A decline would pare the currency’s 2.4 percent gain from a five-year low of 105.44 reached on Jan. 2.

At the end of March, strategists surveyed by Bloomberg predicted a 1.7 percent slide in the yen by mid-year to 105. The currency ended up climbing 1.9 percent last quarter.

Closer Link

The 60-day correlation between dollar-yen exchange rate and Japan’s benchmark Topix index of stocks climbed to 0.42 on Aug. 7, the highest level since December and up from as low as 0.16 in February. A reading of 1 would indicate the two were moving in lockstep, while minus 1 would signal the opposite. The positive reading suggests that, more often than not, the yen weakens as Japanese stocks rise.

“Something that kick starts fresh Japanese investment overseas” is key to weakening the yen, said Simon Derrick, the London-based chief foreign-exchange strategist at Bank of New York Mellon Corp. He sees the currency sliding toward 104 to 105 by year-end.

“GPIF could be just the thing to do that,” Derrick said by phone on Aug. 18. “It could turn out to be one of the key factors in driving the yen lower over time.”

The yen’s 2014 gains are paring last year’s 18 percent slide in the wake of the BOJ’s unprecedented easing program. While such stimulus tends to weaken a currency by increasing the money supply, the main aim of Japan’s policy was to end the deflation that blighted the country for a decade and a half.

Growth Slowdown

The BOJ kept the policy unchanged at its meeting this month, though strategists speculate that a struggling economy will force it to extend the program sooner rather than later.

Gross domestic product shrank at an annualized rate of 6.8 percent in the second quarter, after growing 6.1 percent in the prior period. Morgan Stanley predicts the central bank may ease policy further around October, Ian Stannard, the bank’s head of European foreign-exchange strategy in London, said yesterday.

Hedge funds and other large speculators are increasing bearish bets on the yen, according to the Commodity Futures Trading Commission in Washington. The difference in the number of wagers on a decline in Japan’s currency versus those on a gain -- or net shorts -- jumped to 95,399 contracts in the week through Aug. 5, the most since March.

GPIF and other pension funds will add about 7 trillion yen of Japanese shares and 16 trillion yen of foreign assets within 18 months to 24 months of the revamp taking effect, according to Nomura Holdings Inc., Japan’s biggest brokerage. It predicts the yen will fall about 9 percent to 112 per dollar by year-end.

“The GPIF changes create a perfect storm,” Yunosuke Ikeda, Nomura’s Tokyo-based head of currency strategy, said yesterday by phone. “Once we have a clearer picture of GPIF’s investment strategy, hedge funds will make a head-start on shifting capital.”