Intervention Failing as Yen Poised to Gain

By Masaki Kondo - Dec 27, 2011 11:06 AM GMT+0700

There’s been no better currency in 2011 than the yen and strategists forecast more gains, even as Japan promises to intervene again in foreign-exchange markets and expands the world’s biggest debt burden.

The yen’s advance against every major currency, including a 4.1 percent climb against the dollar, illustrates the anxiety in global markets as Europe’s debt crisis stretched into a second year on the heels of the collapse of Lehman Brothers Holdings Inc. and the U.S. housing market crash. Though bond yields in Japan are the second-lowest in the world and government borrowings are double the size of the economy, foreign ownership of its debt is the highest since 2008.

Japanese officials sold at least 14.3 trillion yen ($183 billion) this year to stem gains that cut profits for exporters from Toyota Motor Corp. to Nintendo Co., and Finance Minister Jun Azumi has pledged more action. Intervention in 2012 may fail again as financial turmoil attracts investors to the world’s third-most traded currency for its low volatility.

“When avoiding losses trumps profits during a period of risk aversion, low-volatility assets are very appealing,” Masashi Murata, a currency strategist in Tokyo at Brown Brothers Harriman & Co., said in an interview on Dec. 19. “When the U.S. and Europe moved in a bad direction and people wanted to avoid risk, the yen stood as the only currency that had enough liquidity to absorb demand.”

Risk-Adjusted Returns

Besides its gains against the dollar, the world’s primary reserve currency, the yen is also the best performer among major peers after filtering out price swings, strengthening 0.5 percent, according to risk-adjusted return data compiled by Bloomberg. Japan’s is the only Group-of-10 currency seen rising versus the greenback next quarter, strengthening to 77 per dollar by March 31, analyst forecasts show.

The U.K. pound and Swiss franc were the second- and third- best performers against the dollar in 2011, finishing unchanged and down by 0.1 percent on a risk-adjusted basis. South Africa’s rand fared the worst, weakening 1 percent after taking into account price swings, followed by the Mexican peso’s 0.7 percent loss.

Gains in Japan’s currency underscore the retreat from risk and losses in carry trades, whereby investors borrow in low- interest regimes to invest in higher-risk, higher-return assets elsewhere. Carry trades involving borrowing yen to invest in the currencies of Australia, South Africa, Mexico and Brazil have lost 9.1 percent this year, according to Bloomberg data, reversing a 1 percent gain in 2010.

Yen Bets

The Japanese currency traded at 77.93 per dollar and 101.86 versus the euro as of 12:55 p.m. today. For the year, the yen advanced 4.1 percent against the greenback and 6.6 percent against the 17-nation currency.

The difference in the number of wagers by hedge funds and other large speculators on a rise in the yen compared with those on a drop was 24,476 on Dec. 20, data from the Washington-based Commodity Futures Trading Commission show. As recently as April there was a net 52,983 contracts betting on a decline.

Japan’s nominal gross domestic product is about the same as it was in 1992, following the collapse of the nation’s asset and real estate bubble. The Bank of Japan on Oct. 27 lowered its forecast for the country’s economic growth in 2012 to 2.2 percent from the 2.9 percent projected in July, citing effects from the strong yen.

Job Losses

Toyota cut its earnings forecast for this fiscal year and Nintendo predicted its first annual loss in three decades as currency gains eroded the value of their overseas sales.

Japan may lose 600,000 jobs if the yen stays at current levels, pushing carmakers to shift production overseas, according to a Nov. 21 report compiled by Trade and Industry Minister Yukio Edano and posted on the website of the National Policy Unit that reports to Prime Minister Yoshihiko Noda.

“The environment will remain harsh for exporters because they have to make a business plan taking account of the stronger yen,” said Hiroshi Morikawa, a lead economist at the Institute for International Monetary Affairs in Tokyo, which conducts research projects commissioned by the government. “Japan’s economy is still reliant on exports, so the yen’s appreciation has direct impact over employment, too.”

The yen’s surge to a postwar high of 75.35 to the dollar on Oct. 31 prompted Azumi to order the nation’s third intervention of the year that day. He said on Dec. 20 he wants the ability to take “decisive” action in explaining a ministry plan to raise its intervention war chest to more than 65 trillion yen.

More Interventions

A previous yen record of 79.75 reached in April 1995 stood until March of this year, when a magnitude-9.0 earthquake struck Japan’s northeast, stoking speculation companies would repatriate overseas assets to pay for rebuilding. The currency jumped to 76.25 on March 17, prompting coordinated action by Group-of-Seven nations the next day.

Total currency sales in the year through Nov. 28 were seven times bigger than the 2.1 trillion yen sold in one shot in 2010, according to data from the Ministry of Finance. The currency erased most losses in as short as five days after each intervention and stood about 12 percent stronger on Dec. 23 than the three-year average against the dollar.

The Swiss National Bank has had more success controlling its currency by imposing a ceiling on the franc at 1.20 per euro in September. The SNB promised unlimited intervention, and said the overvaluation poses an “acute threat” to the nation’s economy. The franc has since stayed under the ceiling.

‘Limited’ Effect

Unlike Switzerland, Japanese officials would “have to issue unlimited quantities of government bonds if they want to conduct unlimited intervention,” said Junya Tanase, chief currency strategist at JPMorgan Chase & Co. in Tokyo. “There’s likely to be a unilateral intervention if the yen breaks a record, but history has already proven that its effect is limited.”

Lack of alternative havens is causing investors to buy and hold. Three-month historical volatility in the dollar-yen rate was at 9 percent today, the least since July and compared with a three-year average of 12 percent. The 10.18-yen gap between the Japanese currency’s weakest and highest points of 2011 is the narrowest since at least 1973 when it started to trade freely.

“Once investors bought yen they had no problem holding on to it, and that led to low volatility,” said Daisuke Uno, the Tokyo-based chief strategist at Sumitomo Mitsui Banking Corp., which manages $934 billion in customer deposits. “Lots of their purchases appear to be for long-term holdings.”

Ballooning Debt

A worsening fiscal climate hasn’t been a deterrent. The country lost its AAA grade from a domestic ratings company for the first time, as Tokyo-based Ratings & Investment Information Inc. downgraded Japan by one step on Dec. 21. Takahira Ogawa, the Singapore-based director of sovereign ratings at Standard & Poor’s, said on Nov. 24 that the nation’s finances are “getting worse and worse,” bringing it closer to a reduction.

Japan projects its public debt will exceed 1 quadrillion yen in the current fiscal year, more than double the size of its economy and compared with about $10 trillion for the U.S.

Countering debt concerns and supporting demand for the yen is the fact that Japan has a surplus in its current account, the broadest measure of trade. The surplus shields Japan from reliance on foreign capital and is the world’s second largest after China’s, according to International Monetary Fund data.

More than a decade of deflation has encouraged Japanese lenders to buy government bonds rather than make loans, helping to contain yields. Domestic banks are the biggest holders of Japan’s debt, owning 44 percent of the total at June 30, according to a Ministry of Finance report.

Monetary Policy

The BOJ has maintained its benchmark interest rate at or below 0.5 percent since 1995, also helping to prevent bond yields from rising. Rates on Japan’s 10-year debt were at 0.97 percent yesterday in Tokyo, the second lowest after Switzerland among developed nations.

Overseas money managers have boosted holdings of Japan’s government bonds by 17.2 trillion yen this year through October, poised for the biggest annual increase in four years. Non- Japanese residents accounted for 8.2 percent of the total ownership of sovereign debt at the end of September, the most since 2008, central bank data showed this month.

The extra yield investors demand to hold 10-year U.S. debt instead of Japan’s securities narrowed to 73 basis points in October, the smallest gap since 1990. The yield spread between Japan and Germany dropped in September to the narrowest in more than 20 years. Japanese investors have bought 5.4 trillion yen of foreign bonds and stocks this year through November, poised for the smallest net purchase in four years, data from the Ministry of Finance show.

Because of the narrowing yield spreads, “there isn’t much incentive for Japanese money managers to take currency risk and invest in dollar or euro assets,” said Takuji Okubo, chief Japan economist at Societe Generale SA in Tokyo. “Money isn’t flowing out of the country.”

To contact the reporter on this story: Masaki Kondo in Singapore at mkondo3@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net