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The fall of the Japanese yen increases the potential for broader market problems

The Japanese yen has fallen 20-year lows against the US dollar. That could be bad news for markets beyond Tokyo.

Traders around the world are watching the yen rise and fall, not only to keep up with Japanese markets, but also to measure how investors are feeling globally. Typically, when markets are booming, the yen tends to weaken against other currencies. When markets are turbulent, the yen tends to gain ground.

That dynamic has been reversed this spring.

The yen fell 12% against the dollar in 2022, despite the fall in global equities between Russia and Ukraine. Its decline has been so severe that this year it has been ranked as the worst currency in the Russian Wall or the Turkish lira among the 41 followed by The Wall Street Journal.

If the yen is a smaller currency, its slide may be less important in the financial markets. But the yen is the key to global finance, it is the third largest currency in the world. Its rapid decline will affect not only Japan but also something far away from the country: $ 23 trillion in the U.S. Treasury market.

The Federal Reserve is ready to begin completing its extensive bond purchase program before next month. The central bank relies on investors such as Japanese institutions – the largest foreign buyers of U.S. Treasury – to help absorb a larger Treasury offering in the market.

But the failure of the yen could cut demand for the Japanese Treasury. This is due to the weakening of the yen, as Japanese investors with dollar-denominated assets will have to pay more to protect against the risk of currency fluctuations.

Theoretically, fairly generous U.S. yields should still make Treasurys attractive to Japanese investors. The U.S. 10-year Treasury yields 2.905%; The Japanese government’s 10-year bond yields a relatively low yield of 0.25%.

But hedging has become so expensive that the extra return that a Japanese investor would have had on holding government bonds instead of Japanese government bonds has almost disappeared. After considering the cost of protecting the currency, the difference between the 10-year Treasury yield and the 10-year Japanese government bond yield is just 0.2 percentage points, Goldman Sachs Group Inc..

using the 12-month coverage found in the analysis.

Because of the “weak Japanese yen and fear of releasing expensive U.S. stocks,” Japanese institutions, such as insurance companies, may focus more on their portfolios on long-term Japanese government bonds rather than U.S. assets, said Daisuke Karakama, a major market maker. Mizuho Bank economist in e-mailed comments.

Japanese investors who decide to stay in the Treasurys market can avoid higher hedging costs by removing protection against currency fluctuations, said Ugo Lancioni Neuberger, head of global currency at Berman Neuberger.

But that carries its own risk. If the yen suddenly rises against the dollar, “your profit advantage could be completely eroded in a few days,” Mr. Lancioni said. Traders who opted for the permanent weakness of the yen were burned by the rapid and violent deviations of that bet in the 1998 Asian financial crisis, as well as the great 2008 financial crisis.

The data show that Japanese investors are downgrading foreign bonds. There have been net foreign bond sellers in every month since November, according to the Japanese Ministry of Finance, which sold 2.36 trillion yen ($ 18.4 billion) in foreign bonds last month.

The backlog of buying bonds from Japanese investors would be more pronounced for U.S. members at a particularly inopportune time. Bond investors have already suffered heavy losses this year.

There is a risk that US bond sales could affect other markets as well, something that has happened to investors in the first months of 2021. year, increasing the sharp rise in bond yields, especially during Asian trading hours. US stocks fell.

Many attributed the fall in equities to the rapid rise in bond yields. Higher rates reduce the premium that investors get from holding more risky assets in the Treasury, making the shares less attractive.

Why is the Japanese yen falling so much?

Traders say central bank policies have become increasingly different as this year has pushed the currency down. The Fed raised interest rates in March 2018 for the first time since May 2018 and said it could raise interest rates by six more in the end of the year as part of its efforts to tackle the sharp rise in inflation. But the Bank of Japan has remained steadfast in keeping interest rates close to zero. The growing gap between rates in Japan and other countries has prompted investors to discard Japanese yen assets and take in dollar-denominated assets that offer higher returns. This sent the yen to unpredictable levels earlier this year.

After all, the shares quickly recovered from the 2021 episode, earning a double-digit percentage gain per year. But some investors see the development as a delay.

“If we get another round to sell the bond, that’s likely to hurt the stock,” said Peter Boockvar, investment manager at Bleakley Advisory Group.

There is a reversal of the fall of the yen before investors see bigger waves in the market. Speculators who are charging for the fall of the yen may suddenly deviate from their positions, and the yen will quickly strengthen, not only against the dollar, but also against other highly traded yen currencies, such as the Brazilian real and the Australian dollar.

But so far, there is little evidence of such a move.

Hedging funds are still committed to further lowering the yen, and net positions against the yen have recently peaked more than three years ago, according to the latest data from the Commodity Futures Trading Commission.

“I don’t see the strength that will stop at this point unless Japan changes its tactics,” said Mark Grant, chief global strategist at Colliers Securities.

Another potential driver of the yen’s turnaround: heavier Japanese intervention. The Bank of Japan may consider raising interest rates earlier than expected, or the Ministry of Finance may intervene directly in the currency markets.

However, some investors are skeptical that Japanese officials will be involved.

Inflation has not warmed enough in Japan to justify the Bank of Japan raising interest rates, said Idanna Appio, portfolio manager at First Eagle Investment Management.

“Maybe if the yen were to get significantly worse here or if there was political pressure from other countries like the US saying that Japan was trying to take advantage, they would come in. But I don’t see that happening,” Ms. Appio said. he said.

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For now, some investors are waiting on the sidelines, rather than trying to put their bets on the yen’s movements in time.

“It’s reaching an absurdly cheap level,” said Peter Kinsella, head of Swiss currency banking strategy at Swiss private bank UBP.

Mr. Kinsella was in favor of the yen falling against the dollar until a few weeks ago, when he disbanded the trade because he was too far away. If the yen exceeds 132 or more against the dollar, he said it will consider raising its stakes.

Write to Akane Otani at akane.otani@wsj.com and Caitlin Ostroff at caitlin.ostroff@wsj.com

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The fall of the Japanese yen increases the potential for broader market problems

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