Morning Commentary: Land of the Rising Sun and Falling Rates

Foreign Exchange - Morning Commentary
Land of the Rising Sun and Falling Rates
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Over the weekend, it was reported that Japan’s Government Pension Investment Fund (GPIF) has started to purchase FX-hedged foreign bonds with bond holdings reaching ~1.3 trillion yen through the end of the first quarter.  In simplistic terms, when Japanese investors purchase unhedged foreign bonds, they have to sell yen to raise funds which puts pressure on a currency to depreciate.  By purchasing FX-hedged foreign bonds, this yen selling pressure gets negated by yen purchases.   
Because interest rates in Japan are so low, 2018 has seen a steadily increasing demand from Japanese investors for higher yielding foreign assets.  This has led to consistent yen selling and is one of the key reasons why, in inflation adjusted terms, the yen is near historically weak levels.  Now with the GPIF, a major player in the investment world, beginning to hedge its investments, does this signal end of investment related yen depreciating pressure? 
While mechanically hedging foreign investments does decrease depreciating pressures, this new development isn’t necessarily a game changer.  It is important to remember that the GPIF is still a net yen seller.  Additionally, there are other players out in the market, such as retail investors and life insurance companies that continue to purchase unhedged investments.  Lastly, Japanese overseas investments are not just limited to bonds, but also include equities and foreign direct investments. 
Although, when it comes to the yen, the more immediate catalyst will be the central bank meetings this week.  The BoJ meets tonight and while it isn’t expected to cut rates, it is possible that it will ease through a strengthening of its forward guidance.  If statement language indicates that the BoJ stands ready to ease further, including cutting rates more negative, it would be sending a stronger signal than its recent verbal assurances have been. 
But questions remain as to whether the BoJ has the sufficient tools to move the yen as it remains highly constrained.  As such it seems that the fate of USDJPY is more likely in the hands of the Fed this week.  With a 25 bps point cut a near certainty, the focus should be on Powell’s press conference and indications on the depth and breadth of Fed’s easing cycle. 
  • The GBP continues to find itself under the pressure of Brexit.  The most recent catalyst has been comments from Boris Johnson’s new cabinet members indicating that the government is ramping up no-deal preparations.  In fact, a top aide has a stated that a no deal outcome is a “very real prospect,” which is a vastly different characterization of Johnson’s “million to one” description during his campaign.      
  • Later this week the Bank of England (BoE) meets and the UK will also hold by-elections.  The BoE is expected to hold rates steady and the by-election should reduce the government’s majority to two seats (inclusive of DUP support). 
  • US-China trade talks are back in the headlines with US negotiators in Shanghai.  While face to face talks are positive, the prospects for a long term deal in the near term remain small.  A good market outcome would include China purchasing more soy in exchange for a freezing of tariff increases. 
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