TOKYO: Expectations of further yen weakening are getting more entrenched among investors, as seen in tumbling hedging costs after the Bank of Japan (BoJ) raised interest rates while pledging to keep policy easy.
Three-month yen basis swaps, used by Japanese money managers to protect against a strengthening local currency eroding the value of their foreign investments, illustrate that.
The instruments, which indicate decreasing demand for hedging the more they rise, closed at the highest level since January 2022 last week. It’s been a tough couple of years for Japanese funds seeking higher returns overseas as the yen lost almost a quarter of its value, making it pricier to buy assets abroad.
Currency hedge costs also soared as Japan kept negative interest rates until this month while global peers rushed to tighten policy to tame inflation.
Signs of a decline in hedging demand suggest that local investors are less concerned the yen will rebound sharply.
“Japanese real money investors buying overseas assets on an unhedged basis are pushing the yen-dollar basis higher,” said Shoki Omori, chief desk strategist at Mizuho Securities Co in Tokyo.
“Given that Japanese real money investors started to think the dollar-yen will not go down significantly in the short term, investors started to consider buying assets that have good yield pickup if they bought them outright, such as US Treasuries and US credit.”
Despite the BoJ’s first rate hike since 2007 last week, various factors point to pressure on the yen to weaken.
Those include the still-wide yield spread between the United States and Japan, with Treasury yields about 3.5 percentage points higher than their Japanese equivalents. The yen has weakened more than 1% against the dollar since the BoJ decision.
Japanese officials have warned they may act to counter the yen’s drop, saying this week that the moves are speculative, but that’s elicited little reaction in the market.
Ten-year Treasuries’ 3.5 percentage point yield premium over Japanese debt means that if that spread doesn’t change, a yen-based investment in US securities will remain profitable as long as the dollar is stronger than about 146.10 yen. It was at 151.39 yesterday. — Bloomberg
