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Beware of Precarious Yen Weakness - Global Exchanges

FICC Podcasts March 30, 2021
FICC Podcasts March 30, 2021


In this episode, we discuss the extraordinary decline we’ve seen in the Japanese yen in the first three months of 2021 and the flows behind it.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

Podcast Disclaimer

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Greg Anderson:

Hi, welcome to episode five of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my cohost Stephen Gallo and I will be talking about the extraordinary decline we've seen in the Japanese Yen in the first three months of 2021. The title for this episode is, beware of precarious Yen weakness.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges presented by BMO capital markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's cohost.

Stephen Gallo:

In each weekly podcasts like today's we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO capital markets, it's affiliates or subsidiaries.

Stephen Gallo:

So Greg here we are on March 30th. It's the final stretch of Q1 for the Western world and for Japan, it's also financial year end. And one of the things that stands out this quarter is broad-based Yen weakness. So this is a great topic to be podcasting about, right?

Greg Anderson:

Indeed, this is a fascinating topic, even for those who don't actively trade Yen. Just three months ago, we were at 103 in dollar Yen, and momentum seemed likely to take us toward 100. Japanese officials were concerned because they really didn't want to see the pair dip below 100. Well, now here we are three months later and dollar Yen is at 110. So call it 7% higher. And while U.S. dollar strength is clearly part of the story, the Yen weakness is broad-based. Just sticking with Mike currencies we've seen a move in Aussie Yen from 79 to 84 so call it 6% and from 81 to 87 in CAD Yen. So call that 7%. Now, Stephen, you wrote a weekly, a couple of weeks ago about Euro Yen, what is the move been in that pair this quarter?

Stephen Gallo:

All great points Greg, and yes, Euro Yen we've seen a two and a half percent rise in spot quarter to date. And here's another one to put in the basket of interesting currency pairs, China Yen, CNY Yen is also up two and a half percent so far this quarter. The other point to make about these currency pairs is that they're making multi-year higher. So Euro Yen and China Yen are both now at their highest levels since 2018. So Greg, I have to ask you plainly and simply what's driving this Yen weakness do you think?

Greg Anderson:

Before answering with what I think, I want to start with what I think the market thinks. In financial markets, the number one story for the quarter is the rise in 10 year bond yields. Most of the focus is on U.S. dollar denominated 10 year yields, but there's been a similar spike in Aussie and CAD 10 year yields. I think the market thinks that higher yields are causing Japanese real money investors to run out and buy a bunch of unhedged long tenure treasuries and Australian and Canadian government bonds. And those outflows from the bond purchases are what is behind Yen weakness.

Stephen Gallo:

But you seem unconvinced by that logic Greg, don't you? I mean, personally, I find it hard to believe that bond flows are solely responsible for these moves because aren't a large portion of those flows currency hedged?

Greg Anderson:

Yes, Stephen, a good rule of thumb is that 80% of bond flows are FX hedged, but moreover, in this case there aren't flows. Japan publishes weekly data that details how much worth of foreign bonds Japanese investors have purchased and how much worth of Japanese bonds foreigners have purchased for that week. Guess what? According to this data, Japanese investors have added 339 billion Yen in foreign bonds. Admittedly that sounds like a lot, but it's only 3 billion U.S. dollars, which is a proverbial drop in the bucket for a market with as much liquidity as dollar Yen. But here's the clincher Japanese real money investors have reduced their foreign equity holdings by the equivalent of U.S. $20 billion. In other words, the net portfolio flow from Japanese real money investors for the quarter is inbound, which one would think would cause the Yen to strengthen.

Stephen Gallo:

Well, as you pointed out, Greg, it's not Japanese investors who are pushing the Yen lower, but let me tell you what the IMM CFTC positioning data say. At the start of the year leveraged funds were running a monist net long position in the Yen. But if you fast forward to the second half of March where we are now, what do we see? Well, it's completely flipped. Leveraged funds are holding their biggest short Yen position since 2018 and net short Yen is the biggest position in any currency, including the dollar. So the net short position currently about $5 billion versus the aggregate net long position in the U.S. dollar of $1.9 billion. So basically Greg, what it looks like here is that there is a misalignment between what the real flow are signaling on the one hand and what the speculative flow is signaling on the other. What do you think?

Greg Anderson:

Yeah, that's right. And it's a bit unusual. Normally leveraged funds and real money funds are taking the same positions in the same direction at the same time in a given currency pair. With the peculiarities that surround Japanese financial year end, I could argue that maybe real money investors have been pulling back on foreign exposures to keep them under a financial year end limits. If that's the case, maybe leverage funds are anticipating those real money outflows in April. And if we do get those flows, then short term speculators can exit short Yen positions and move on to the next trade without their exit disturbing the market. But if those real money outflows don't show up in April, then speculators are left holding the bag so to speak. This type of 5% ish movements in dollar Yen based off of position taking in this speculative heard happened almost every year in dollar Yen. And in general, I haven't seen U.S. policymakers care too much about it. What about policy makers in the currency you covered Stephen?

Stephen Gallo:

I don't think policy makers in Europe will be too perturbed about European strengthening Greg, largely because numerous factors have caused the broad value of the Euro to weaken over the last couple of months to the point where it's now trading slightly lower year to date. And that point is important I think because it goes a long way towards undercutting the notion that strong Euro fundamentals have been largely responsible for this move up in Euro Yen. In fact, net capital outflows from the Eurozone have if anything increased in intensity during the months we have data for particularly Q4 and early Q1. And on top of that, the ECB balance sheet has been growing at a faster rate than the BOJ. So I think at the very least Euro Yen is likely to encounter more headwinds.

Greg Anderson:

What about China Yen, Stephen? What if that pair moves higher?

Stephen Gallo:

So first off Greg, one of the things I have to point out is that one of the reasons the RMB is appreciating against the Yen is purely mechanical. In other words, China has been keeping the RMB stable against the overall CFETS basket, but also letting the RMB depreciate against the dollar. So China Yen is just mimicking the move up in dollar Yen. But I do think there is a chance that if China Yen moves any higher, the degree of sensitivity to the move in Beijing will also move up. I mean, naturally China and Japan have strong trading links, but more importantly, they also compete with one another on their goods exports in Western markets. So this is an important currency pair for policy makers in Beijing.

Greg Anderson:

So let me try to summarize Stephen. The broad Yen has weakened about 5% this quarter, primarily due to speculators shorting it, not due to Japanese investors running out to buy higher yielding foreign bonds. Now this may not end badly for speculators and it won't if Japanese real money buys a bunch of foreign assets in April. However, this is a precarious situation, a bit like a House of Cards and other countries like China would have some incentive to try to topple this House of Cards or it might collapse on its own.

Stephen Gallo:

That's a great point to end on Greg. And this is going to be especially fascinating to watch play out in real time over the course of April. So we'll leave it there. For those of you still listening thanks for tuning in, and we hope you'll join us in two weeks for our next edition.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Incorporated and BMO Capital Markets Corporation. Together BMO who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy referenced here in maybe suitable for you. It does not take into account the particular investment objectives, financial conditions or needs of individual clients.

Speaker 3:

Nothing in this podcast constitutes investment, legal accounting, or tax advice or representation that any investment or strategy is suitable or appropriate to your unique circumstances or otherwise it constitutes an opinion or a recommendation to you. BMO is not providing advice regarding the value or advisability of trading in commodity interests, including futures contracts and commodity options or any other activity which would cause BMO or any of its affiliates to be considered a commodity trading advisor under the U.S. Commodity Exchange Act. BMO is not undertaking to act as a swab advisor to you or in your best interest in you to the extent applicable. We will rely solely on advice from your qualified, independent representative making hedging or trading decisions.

Speaker 3:

This podcast is not to be relied upon in substitution for the exercise of independent judgment. You should conduct your own independent analysis of the matters referred to here in together with your qualified independent representative if applicable. BMO assumes no responsibility for verification of the information in this podcast, no representation or warranty is made as to the accuracy or completeness of such information. And BMO accepts no liability whatsoever for any loss arising from any use of or reliance on this podcast. BMO assumes no obligation to correct or update this podcast. This podcast does not contain all information that may be required to evaluate any transaction or matter and information may be available to BMO and or the affiliates that is not reflected herein. BMO and its affiliates may have positions long or short and affect transactions or make markets and securities mentioned herein or provide advice or loans to or participate in the underwriting or restructuring of the obligations of issuers and companies mentioned herein. Moreover, BMO's trading desks may have acted on the basis of the information in this podcast. For further information, please go to bmocm.com/macrohorizons/legal.

Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy



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