There's a Big Reason to Watch Out for the 'Unwinding of Yen Strength'

Don't fight the flows.
Photographer: Kiyoshi Ota/Bloomberg

Go figure.

One of the best performing major currencies in the first quarter has been one whose central bank implemented a negative interest rate regime in the first three months of the year and has soaked up so much sovereign debt that its most recently issued 30-year bond didn't even trade in a recent session.

We write, of course, of the Japanese yen, which is up nearly 7 percent against the U.S. dollar to date in 2016.

But according to Societe Generale Global Strategist Kit Juckes, one theme for the upcoming quarter will be the "unwinding of yen strength."

The strategist notes that speculators have accumulated a sizable long position in the currency as it gained on the U.S. dollar:

JUCKES JPY 1
Source: Bloomberg

Juckes highlighted the recent Japanese securities investment figures, however, as a sign that flows aren't working in the yen's favor. While futures contracts betting on yen strength have piled up, foreign investment in Japanese stocks and bonds has turned negative at the same time Japanese investors have been accumulating foreign bonds at a rapid pace.

Juckes JPY 2
Bloomberg

"Last week saw the biggest net sales of Japanese bonds and equities by foreigners (2.2 trillion yen) since 2008 and over the last four weeks, we have seen the biggest net buying of foreign bonds by Japanese investors since at least 2000 (4.7 trillion yen)," he explained. "If speculative yen longs are offsetting capital outflows and keeping USD/JPY in the current range, then I know which of these two forces is likely to win out in the end."

While the flow dynamics suggest upcoming softness in the yen, bulls would likely counter by pointing out that repatriation flows associated with benefits paid to retirees are a structural force that will prove conducive to strength in the currency over the medium term.

Juckes indicated that the Swedish krona was SocGen's preferred long position to express this bearish call on the yen, noting that the krona should benefit from any move higher in Swedish inflation as well as increases in risk appetite.

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