Yen: Between Repatriation and Depreciation

Yen: Between Repatriation and Depreciation

Japan's much-awaited anti-deflation package--unveiled in the last week of February-- missed the mark as far as markets were concerned. The package involves two phases: The first will contain measures to stabilize stock prices and a call for additional monetary easing from the Bank of Japan. The second phase, postponed until after March 31 (the end of the fiscal year) will tackle the main issue of tax reforms and the elimination of bad debt loans. Injections of public funds into banks will only be implemented in case of severe financial crisis. This begs the question as to what really constitutes crisis in Japanese terms. The whole package is structured to work in coordination between the government and the Bank of Japan. The package consists of two parts instead of one due to Diet's (the Japanese parliament's) current debate of the budget draft for the coming fiscal year and Koizumi's pledge to keep the 30 trillion yen of bond issuance for the present year.

But markets' expectations were so low that the Japanese government didn't disappoint its critics. Even the Bank of Japan's latest decision to further ease monetary policy had very little effect on sentiment. Overall pessimism with Japan's reform inertia is likely to increase rapidly and push the Japanese currency lower over the medium term. The only obstacle has been seasonal repatriation flows, which occur when Japanese investors sell their foreign-based assets and convert the proceeds into yen to boost balance sheets ahead of the end of half-year and full year book closings in September and March respectively.

While repatriation forces could drag the dollar down to the 131.00-50 region, a waning in these operations in late March may pave the way for a resumption in yen outflows. Thus, USD/JPY could target the 138-140 once the 135.00/20 major resistance band is broken.

Repatriation Reversal

Japanese repatriation stands on its head the normal pace of outward investment during the months leading up to the fiscal half year-end in September and fiscal year-end in March. But after these periods, outward investment resumes, putting yen under pressure.

Following the half-year end in September 2001, Japanese net investor flows turned sharply outward in October putting the yen under pressure as it fell from around 119.50 to 123.50 against the dollar. Japanese were large buyers of foreign bonds and equities at this time, totaling 5.5 trillion yen -- The largest increase in over 3 years of outward investment.

Consequently, Japanese net portfolio flows are likely to turn negative again in April given the weakness in Japanese stocks and the risk associated with the Japanese government bond bubble. Reversal of repatriation flows should then propel USD/JPY higher.