The yen has quickly dived to near three-year lows, but one Japanese sector with serious currency clout has yet to be heard: big insurers who control a combined $2 trillion in assets.
Conventional wisdom holds that a weakening yen and stronger U.S. dollar will spur insurers to buy more foreign assets as they search for higher returns, which would send the Japanese currency into a steeper tailspin.
The yen has fallen as Prime Minister Shinzo Abe kept to his promises of aggressive reflationary fiscal and monetary policies, but insurance companies seem to be in no rush to change their strategy for now, waiting to see if Abe in the end is any more successful than previous leaders in resuscitating the long ailing economy.
Many still remember being burned in 2005 to 2007 when they underpinned a steady rise in the dollar with foreign investment, only to see their profits evaporate as the dollar sank to record lows against the yen over the next five years.
Analysts say their absence from the market will not derail what appears to be an extended period of yen weakness, but it could limit further losses and leave the currency more vulnerable to corrections to the upside if selling pressure abates.
“Markets are still not fully convinced that Abe can push through the most essential of his policy mix, the growth strategy, which requires a painful overhaul of current frameworks that inhibit growth, but for which no roadmap is provided,” said Yuuki Sakurai, CEO at Fukoku Capital Management.
Others agree.
“Japan’s monetary policy framework is entering uncharted territory and we need to see through what these bold measures are. It’s not the time to take sides, but to stay sidelined,” said Kazuto Uchida, an executive officer and general manager of the global markets division at the Bank of Tokyo-Mitsubishi UFJ.
WILL “ABENOMICS” SUCCEED?
Abe’s calls for concurrently pursuing unconventional reflationary monetary policy, ramping up public spending to buoy domestic demand and tapping strategic growth areas are challenges his predecessors had all failed to achieve.
Nevertheless, speculators betting on “Abenomics” and bolder policy easing by the Bank of Japan have driven the yen down about 20 percent against the dollar and pushed up Tokyo stocks by more than 30 percent since mid-November.
Still, analysts say current yen levels of around 94 to the dollar alone will not justify a swift reallocation by insurers to unhedged foreign assets, as global yields will likely remain historically low for some time while major central banks stick with “cheap money” policies to boost their economies.
“You have to ask, is this stock rally sustainable, can we really believe in ‘Abenomics’, is it really appropriate to bet our investment policy based on unrealised gains brought around by expectations alone?,” said Katsuyuki Tokushima, chief pension adviser at NLI Research Institute.
Industry insiders agree insurers are likely to wait and see how long Abe can sustain market expectations. They will also be watching for any signs of a pick-up in U.S. yields later in the year if the slow U.S. economic recovery remains on track, which could fuel speculation about the Federal Reserve’s exit from its ultra-low rate policy, making hedging costs less tolerable.
CATCH-22
The yen’s weakening trend is a Catch-22 for insurers. It makes sense to start buying foreign assets early if the yen is expected to fall further, as the timing of removing currency hedges affects profitability on foreign asset holdings. But yield differentials have to be big enough to offset currency risks.
“Insurers earn profits from foreign investment because they don’t hedge, that’s how they make profits. I don’t think insurers are mulling taking currency risk to buy (foreign) bonds,” said Sakurai, who previously led investment planning at Fukoku Mutual Life Insurance.
The current U.S.-Japan interest rate differential of just over 100 basis points is too narrow to warrant a switch to unhedged foreign investment, analysts said, saying around 300 bps would represent a more comfortable buffer for currency risk.
“Flows from Japanese investors are needed to push the dollar/yen to reach 100,” said Yunosuke Ikeda, a senior FX strategist at Nomura Securities. “Foreign investors are seeing that they can reinforce short yen bets if insurers make a move.”
With the Fed’s benchmark short-term interest rate pinned near zero, insurers will not increase unhedged foreign bond investment, said Citibank Japan chief FX strategist Osamu Takashima.
Furthermore, insurers are not under pressure to aggressively seek returns at the moment, as the stock market rally in recent months has given them a comfortable capital buffer to ride out the full-year book closing on March 31.
Prospects for higher yields on Japanese government bonds (JGBs), on the back of an expected increase in bond issuances to fund aggressive fiscal stimulus, also could blunt investors’ appetite for foreign assets. If policy measures work, then yields will likely rise on expectations of a return to inflation, particularly at the long end of the curve.
Analysts say insurers’ liability duration averages 15-20 years, so if Abe’s reflation materialise and boosts 20- and 30-year JGB yields to 2 percent and 3 percent respectively, insurers could stick to investing in JGBs.
While investors remain wary of a firming yen if Abe disappoints, any gains are likely to be contained by yen selling by other types of investors.
Strong dollar demand from Japanese importers to pay for rising fuel imports and increasing short-selling of the yen by retail investors are at least filling in some of the gap left by the absence of large investors.
Data from the Financial Futures Association of Japan showed that retail investors’ dollar/yen transaction volumes rose 125 percent in January from December and by 97 percent in euro/yen in January from December.
“I think that Japanese retail traders and investors are ready for the wave of volatility … Many of them have been on the sidelines for too long and are ready to get back into the market to speculate and place long term investments,” said Javier Paz, senior analyst at Aite Group.
Reuters
