Yen fears portfolio rebalancing

September 30, 2014 07:00 PM

Japan has long spoken about the need to address the nation’s aging population and offer better returns to meet growing pension pay-outs. It is finally addressing the problem, and the yen is falling accordingly.

In early September, Japanese Prime Minister Shinzo Abe named Yasuhisa Shiozaki as new health minister to overhaul the nation’s $1.2 trillion Government Pension Investment Fund (GPIF). The Fund is expected to cut its local bond target to 40% from the current 60%, and raise Japanese shares exposure to 20% from 12%. This would require the GPIF to buy ¥3.5 trillion in local stocks to reach the 20% level.

A bill to overhaul GPIF’s governance structure is expected to be submitted in the next parliamentary session.

As reforms of the GPIF get underway, other funds could follow suit. The governor of Tokyo is said to be considering more aggressive investments of the city’s ¥3.4 trillion fund ($32 billion), deploying them into higher-yielding securities such as equities, property and other high-returning domestic and foreign assets. There are at least three other Japanese pension funds considering a similar overhaul: The Federation of National Public Service Personnel Mutual Aid Associations, the Pension Fund Association for Local Government Officials and the Promotion and Mutual Aid Corporation for Private Schools of Japan, each with allocations to domestic equities ranging from 5% to 14% of assets. Japanese officials also have mentioned California Public Employees’ Retirement System (Calpers) as a model for the GPIF re-balancing. The $300 billion Calpers fund has 50% of its assets in global equities. 

FX Implications 

The currency implications of a rebalancing in the GPIF’s equity portfolio would be enormous. The 7% yen decline against the U.S. dollar over the past few months could be just the beginning. A reduction in the JGB’s allocation may boost yields, especially if the current bounce in global bond yields is maintained. Such a move would likely occur if Japan’s inflation remains on an upward path towards the new 2.0% target. 

The possibility of seeing a 109 print in USDJPY is increasingly plausible as Japanese investors’ search for yields is satisfied abroad. The Federal Reserve’s baby steps towards monetary policy normalization following the targeted end of QE3 expected at the October Fed meeting should boost the USD-part of USD/JPY as long as U.S. data maintains recent momentum in labor markets. Further yen weakness also would mean a further run-up in the Nikkei-225. A 7.5% rise in the Nikkei to 17,000 from current levels could well be on the way as long as Tokyo’s efforts to reflate the economy are proven successful. The major impediment to such a rally will be the fate of consumer spending, which is already dampened by the April tax hike from 5% to 8%. Credit rating agencies are pressuring Tokyo to stick with plans to levy another tax hike for October of next year.  As long as none of these developments interrupt risk appetite in local and global equities, the road to 109 yen and 17,000 Nikkei may well happen by year-end. 

Alternatively, FX traders could consider CAD/JPY as the cross rate tests the top of its 16-month channel, a break of which could see a recall of 99.90 (see “A yen for loonies,” below). Underpinned by positive oscillators on the weekly and monthly charts, CAD/JPY appears an attractive candidate for buying the dips as long as the 94.00 trendline support remains intact. CAD/JPY bulls and yen bears may encounter a few scares in October as markets grapple with the Federal Reserve’s plan to end QE3. A surge in volatility accompanied by falling equities, rising yen and declining bond yields is inevitable, but unlikely to dislocate the pace of economic recovery in the United States and Canada. With Canadian interest rates already above those in the United States, UK, Eurozone and Japan, CAD/JPY bulls will likely see further gains, but not before a temporary dip.

Ashraf Laidi is Chief Global Strategist at FX Solutions/City Index, founder of and author of “Currency Trading & Intermarket Analysis.”

About the Author

Ashraf Laidi is chief global strategist at City Index-FX Solutions and author of “Currency Trading & Intermarket Analysis.” His Intermarket Insight appears daily on