“Japanese Flows and Yen Indicate Market Recovery from BOJ Concerns” – Reuters

By Gaurav Dogra and Brigid Riley

Japanese investment figures released on Friday indicated a trend that the weakening yen had suggested throughout the week: following a period of significant market instability, global investors are now wagering that the Bank of Japan (BOJ) will adopt a gradual approach to interest rate increases, resulting in a persistently low yen.

Data from the Ministry of Finance showed that in the week leading up to August 10, Japanese investors made the largest investments in long-term foreign bonds in 12 weeks and also engaged heavily in short-term foreign debt purchases.

The yen has been on a steady decline this week, halting a sharp rally that began in early August. This decline was influenced by the BOJ’s unexpectedly hawkish stance on possible further rate hikes, alongside concerns about a potential U.S. recession, which triggered a significant unwinding of yen-financed carry trades.

The recent capital flows and the yen’s depreciation have led to speculation about the slow return of carry trades, although opinions vary.

Yusuke Miyairi, a G10 currency strategist at Nomura in London, commented, "It seems that the short covering of the yen has taken place, and current positioning appears light. However, the question remains: is the carry trade truly back? While dollar-yen is nearing 150, the foreign exchange market still experiences relatively high volatility."

On Friday, the yen hovered around the 150 mark, significantly above the 38-year lows recorded last month but also well below the 141.675 high reached on August 5. These dramatic fluctuations have contributed to sustained volatility, which typically hinders carry trades.

Yet, the prospect of betting against the yen appears more favorable to investors after BOJ Deputy Governor Shinichi Uchida tempered the central bank’s hawkishness. Additionally, recent data indicated a reduction in leveraged funds’ net short positions on the Japanese yen, marking the lowest stance since February 2023.

A more aggressive BOJ approach could lead to higher yields on Japanese government bonds, prompting repatriation of Japanese investments and potentially disrupting the weakening yen scenario essential for carry trades, explained Rong Ren Goh, a fixed income portfolio manager at Eastspring Investments. He stated, "The BOJ’s assurance not to hike rates amidst market instability acts as a safeguard for domestic investors’ overseas investments."

Investment Flows

Japanese investors purchased 1.54 trillion yen in long-term foreign bonds last week—the highest net purchase in 12 weeks—while acquiring a net 453.5 billion yen in short-term instruments. Conversely, they sold off foreign stocks, amounting to a net outflow of 328.1 billion yen, following three consecutive weeks of net purchases.

Miyairi from Nomura advised caution in interpreting the flows data regarding yen positioning, as certain Japanese investors, particularly banks, frequently utilize interbank repurchase agreements to finance their bond purchases.

On the other hand, international investors bought approximately $3.5 billion worth of Japanese shares last week, reversing three weeks of net selling during a period when the stock average experienced its most significant one-day drop since 1987. The Nikkei index has since surged over 20%.

Foreign investors have also shifted from an eight-week trend of selling Japanese bonds to become net buyers, acquiring 1.44 trillion yen in long-term bonds (the largest since May 11) and 561.8 billion yen in short-term securities.

According to Masafumi Yamamoto, chief currency strategist at Mizuho Securities, this kind of "bargain hunting" may persist as the yen stabilizes and recovers its footing. He noted, "The underperformance of Japanese equities has presented a valuable opportunity for foreign investors to make acquisitions."