The Japanese currency is trading at a two-decade low as retail investors continue to shift funds abroad, where better returns lie
Kiyohiko Nishimura's popularity with Japanese women is probably at a low ebb right now. On July 2, the Bank of Japan (BNJAF) policy board member compared Japan's growing ranks of female investors to the infamous gnomes of Zurich. That's a reference to comments made in 1964 by Harold Wilson, a British politician, attacking Swiss bankers for pushing down the value of the British pound in the foreign exchange markets.
The charge against Japanese retail investors, including yield-seeking housewives, is that their investment in high-return overseas assets is weighing down the yen, which is currently hovering near a 22-year trade-weighted low against other currencies, after adjusting for inflation. "The gnomes of Zurich were accused in their day of destabilizing markets," Nishimura said in a speech in Washington. "The housewives of Tokyo are apparently acting to stabilize them."
Nishimura added that Japan's ultra-low interest rates—a key benchmark rate is 0.5%—are a big factor in why so many of Japan's retail investors are sending funds overseas, and why, in turn, rates shouldn't be held down too much longer. "To stand pat for a long period of time is not a prudent strategy," he added. Yet on July 12, Nishimura and his BOJ colleagues did in fact hold Japan's key interest rate at 0.5% for the fifth consecutive month. So a sustained appreciation of the yen and a dampened Japanese interest in foreign assets look unlikely in the near future.
Global Effects Expected
On the contrary, most economists and traders foresee further yen weakness. "It is natural for the yen to remain weak when the [Japanese] interest rate remains low compared to other economies," says Masaaki Kanno, chief economist at JPMorgan (JPM) in Tokyo, speaking before today's decision "Everyone, including the housewives in Tokyo, expect the yen to weaken."
Indeed, that widespread expectation is creating headaches for Japan Inc., which so far had been happy to soak up higher earnings made when bringing overseas profits back to Japan. "In the longer term, the weak yen will have side effects on global strategies," says Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo.
One example, says Matsumoto, is that automakers could delay opening new plants overseas because it's cheaper to export from Japan. But that raises the risk of political reprisals in overseas markets in the future. There's also a risk that easy profits breed complacency. "The yen's current weakness makes it too easy for us," Komatsu Chairman Masahiro Sakane said in late April.
Sophisticated Overseas Investing
But why is the yen still looking like a one-way bet? It's not just low rates in Japan. One problem is that other central banks are tightening monetary policy more quickly than the BOJ. In Britain, the Bank of England has raised its overnight lending rate by 0.25% five times in the last year.
In New Zealand, another big target for Japanese investors, benchmark rates are now at 8%—a full 7.5% higher than Japan's rate. The European Central Bank is also expected to raise the euro interest rate again in the coming months. And while the Federal Reserve has kept U.S. benchmark rates at 5.25% for eight months, it remains considerably higher than the yen rate.
Another factor is the sheer determination, and increasing sophistication, of Japanese retail investors. Seeking higher yields overseas often means buying foreign stocks and investment trusts. Many investors, though, are favoring leveraged currency investments, contributing to yen weakness.
On July 6, Bloomberg News reported that bets against Japan's currency by individual investors using borrowed funds exceeded those of traders on the Chicago Mercantile Exchange. According to Tokyo-based Yano Research Institute, Japan's increasingly risk-loving investors have opened 660,000 margin trading accounts—as the leverage deals are known—with brokers that lend money to increase bets. That's twice as many accounts as a year ago.
Low Consumer Confidence
Then there's Japan's economy. On the one hand, Japan is enjoying its longest period of unbroken growth in the postwar era and will post steady gross domestic product growth of around 2% this year. On the other, shaking off deflation remains a headache. Since the last interest rate rise in February, the consumer price index has been negative for four straight months, weakening the case for a rate rise.
New consumer confidence data released July 11 also failed to force a case for a rise. The data, released by Japan's Cabinet Office, showed consumer confidence in June was at its lowest level since December, 2004, amid fears over higher taxes, falling wages, and pensions. "From an orthodox economics perspective, it's hard to make a case for a rise," says Richard Jerram, chief economist at Macquarie Securities in Tokyo.
It's also difficult to make a case for buying stocks at home. This year, the Nikkei 225 index has risen 6% and looks unlikely to catch fire soon. What's more, those investing in foreign markets also have received an extra bonus as the yen has weakened. "There's no particular reason for investors to take whatever they've invested outside the country and bring it back," says James Tyrie, head of foreign exchange trading at HSBC (HBC) in Tokyo.
No Desire for Intervention
For all that, most Tokyo watchers expect interest rates to rise to 0.75% in August because the BOJ has signaled a commitment to "normalize" interest rates. By then, an imminent election in Japan's Upper House will be out of the way. And there are signs the government would accept an increase without putting undue pressure on the BOJ, as has been the case in the past.
One reason: If the rise doesn't come as expected in August, the yen may weaken further, which could increase international pressure on the Ministry of Finance to intervene. "Intervention is a very strong medicine and I don't think they want to do that," says JPMorgan's Kanno. "Gradually [raising rates] is much better and sends a sign that people shouldn't borrow too much to buy foreign currencies."
What is clear is that in the absence of some kind of economic shock, the Japanese appetite for investing overseas shows few signs of abating.