What's With The Dollar-Yen?

The US dollar had been in a broad trading range against the yen since last December. The marginal new high seen in March to about JPY122 proved to be a false break and the dollar returned to its well-worn ranges. After testing the lower end of an even narrower range around near JPY119 on May 14, the greenback has rallied about 4% to approach JPY123.80 earlier Wednesday. This is the highest level the dollar has reached against the yen since June 2007 (~JPY124.15), which itself was the highest since the end of 2002 (JPY125.70).

To the extent that the yen's decline stands out, it is not due to the magnitude of the move. Since May 14, the yen has actually held up better than most of the other major currencies. Sterling has fared better, rising about 2.8% against the dollar. The New Zealand dollar has performed slightly better than the yen. The yen has done considerably better than the euro over this period, which has fallen by a little more than 5% against the greenback.

The erosion of the yen has taken place as US yields have slipped lower. The U.S. 10-year yield peaked near 2.36% on May 12 and is back to 2.14% now. While US 10-year yield is about 22 bp lower, the 10-year JGB is about 6 bp lower. Nor is a rally in US stocks a likely catalyst. The S&P 500 is slightly lower than the 2121 close on May 14.

Japanese stocks are up about 4.6% during this period of yen weakness. In fact, Japanese shares are on a nine-day advancing streak. It is the longest positive run since last June. There are three strong sources of demand for Japanese shares, but foreigners do not appear to be among them. As part of its QE efforts, the BOJ is buying equity ETFs and is accounting for around half of the activity in the ETFs it buys. Japanese pension funds are also substantial buyers of domestic equities as they diversify away from the JGB market. Japanese companies flush with cash, area also buying back their own shares.

Foreign investors turned larger buyers of Japanese equities after the BOJ surprised on a 5-4 vote to increase its balance sheet by JPY80 trillion from JPY60 trillion last October. The four-week average (used to smooth out the week-to-week volatility) rose to the highest since 2011 when the time series bag. It reached JPY900 bln. Foreign investors were mostly sellers at the start of 2015, and the four-week average still showed divesting through late February. They turned back to the buy side in the first half of March and turned more aggressive in April, the start of the current fiscal year. The four-week average moved back to JPY874 bln at the end of last month. However, here in May, the buying has dried up, and the weekly average here in May has slipped below JPY20.

The correlation between the dollar-yen and stocks is not statistically significant. However, on a percentage change basis, over the past 60-days, the correlation between the dollar-yen and Nikkei 225 is slightly positive (0.15), while the correlation with the S&P 500 is slightly negative (-0.09).

Minutes from the BOJ's April meeting were published earlier Wednesday. Officials are still concerned that its 2% inflation target, which it had hoped to achieve the currency fiscal year. It pushed it out to "around the first half of fiscal 2016." There are doubts about even that. There was an attempt by a quarter of the Board to soften the language to "in or around fiscal 2016", but they failed to sway the majority and thus dissented from the official statement.

Separately, the BOJ indicated that it made an operating profit of JPY1.7 trillion in last fiscal year. That is a 34% increase year-over-year. Its balance sheet stood at JPY324 trillion. It put JPY380 aside for provisions against foreign exchange losses and paid another JPY342 in taxes (yes, it pays taxes), leaving it with a net profit of JPY 1 trillion. The BOJ is keeping about 25%, up from 20% in the previous fiscal year and transferred the rest to the national government.

The G7 finance ministers meeting ahead of the G7 summit early in June is unlikely to levy criticism against Japan for the weakness of the yen. For the most part, Japanese officials have refrained from jawboning the yen. The bill in the US Senate that had tried to have toughen the currency manipulation penalties as a condition on granting Trade-Promotion Authority to President Obama and his successor failed in the last instance.

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