The strength of the Japanese yen continues to befuddle policy makers, investors and observers. It is often claimed to be a safe haven, even though the country does not have a triple-A rating, has a debt-to-GDP ratio of more than 200% and continues to be plagued with outright deflation.
Yet the "safe haven" claim, like the "carry trade" claim to explain pre-crisis periods of weakness, lives a mostly unexamined life. While not pretending on offering a grand explanation for the yen's strength here, we share the following eight observations:
1. The safe haven hypothesis would lead one to expect to find that foreign investors have stepped up their purchases of Japanese financial assets, but this is not the case. The weekly Ministry of Finance data show fairly consistent and low demand. The 4-week average of foreign purchases of Japanese stocks and bonds stands at JPY72.8 bln. The 26-week moving average is just below that at JPY71.4 bln.
2. The Ministry of Finance data show relative strong demand recently for Japanese money market instruments. The 4-week average stands at JPY453.2 bln, more that twice the average from the year ago period. The 26-week moving average is a more modest JPY39.6 bln, which is a little less than half the year ago average. Separately, Fitch reports that Japan is the beneficiary of the shift by large US money market funds fleeing Europe. It notes that since May 2011, these funds have doubled their exposure to Japan.
3. Judging from the currency futures, speculators also cannot be cited behind yen strength. The gross long position (net position is not relevant here) as of the week ending July 17 was a modest 36.7k contracts. Recall that in early February, the speculative gross position of over 85k contracts, a multi-year high only to fall to a multi-year low near 1k contracts by the end of March.
4. Japan is no longer the low interest rate country. Yet Japanese investors, who have long demonstrated a clear and strong preference for foreign fixed income investments over equities, have not been deterred. The four-week moving average of foreign portfolio investment is near a two year high of JPY743 bln (which includes a small sale of foreign equities).
5. At the end of last week and the start of the this week, the 3-month implied dollar-yen volatility was trading below 7.5%, to reach its lowest level since Oct 2007. Although it briefly moved to 8%, but is coming back-off. In addition, as we observed earlier this year, in what appears to be unprecedented, dollar calls/yen puts are traded at a small but positive premium over dollar puts/yen calls. In the past, extreme yen bullishness was seen in the premium traders/investors were willing to pay for yen calls over yen puts. Even the euro-yen volatility is not particularly high. Over the past three-years, 3-month implied volatility has traded between about 10.8% and 23%. It is currently near 13%.
6. The fact that the speculative position seems neither large nor extreme, that volatility is low and the skew in the options markets if anything is negative the yen, Japanese officials are hard pressed to argue under in favor of intervention under the G7 recognition of the importance of stable markets. Simply put the yen cannot get much more stable.
7. Deflationary pressures and the strength of the yen may not lead to material intervention as soon as the jawboning would have one believe, but it may do what the government wants the BOJ to do, step up its efforts to arrest deflation as it promised. The June national CPI showed a 0.2% decline from a year ago. It is the first negative print here in 2012. Two new BOJ board members have been confirmed and while they sound dovish, convincing the majority at their first meeting seems a bit of a stretch.
8. Over the past week the dollar has built a small shelf near JPY78.00. Some indicators like RSI and MACDs provide some technical evidence that a near-term bottom is being carved out. The upper end of the range is seen near JPY80. A firmer dollar against the yen might coincide some weakness of the yen on the crosses, on ideas that the central banks will once again provide monetary support, as early as next week. However, a break of the JPY78 shelf could spur a quick test on the JPY77.65 low seen in early June.