fundamental analysis Hedge Ratio
USD EUR AUD GBP Total
Nissay 62% 41% 0% 0%
46%
Daiichi 65% 55% 37% 46% 60%
the unwind of a popular, widespread and leveraged carry-trade funded in JPY. Carry-trade may be starting to be popular again but for sure we are currently at a very early stage, years away from the accumulation and excesses of the 2004-2008 period. A global slowdown in the near future would mostly fail to fuel notable yen strength (via unwinding carry trades) and most likely would bring yen weakness (via worsening trade balance). And higher oil and slower growth could actually feed on each other. Keep your eyes open…
Watch the Lifers
Another force behind yen strength has
been a raising hedge ratio
implemented by the Japanese life insurers (the so called ‘Lifers’) on their massive portfolio of foreign currencies denominated investments. When the short term interest rates differential between JPY and USD was significant, a portfolio of Treasury Bonds (a liquid but better yielding alternative to JGBs) used to be costly to hedge (usually with 3 or 6 months FX forwards). But aſter the 2008 crisis and the ZIRP (Zero Interest Rate Policy) getting more and more popular in the Western world such a
21% 33% 0%
21% (unit: Yen billion)
Sumitomo Meiji Yasuda Mitsui 99% 91% 99%
75% 96%
100% 96%
83% Sep-11
cost became insignificant and hedging (i.e. selling USD/JPY or EUR/JPY etc…) to get some carry on duration (10 years yield remained decently higher than JGB’s ones) without FX risk, got much more popular.
Te tables show the situation (latest official figures available) of the five biggest Lifers at end of September 2011.
Adding to such a picture the hypothesis
FX
of some more of hedging executed in Q4 2011, particularly exploiting BoJ intervention at the end of October, we can estimate current average hedges standing in the 60-65% range, an historically high level.
For the major nine lifers, their foreign bond portfolio amounts to ¥20 trillion (almost 250 billion USD). So a 1% decline in hedge ratio will generate JPY200 billion (or $2.5 billion) selling pressure mostly against USD, EUR, GBP and AUD. For USD/JPY, it should be around JPY100 billion ($1.25 billion). If we see them reduce hedges to assume more FX risk, which could be due to raising hedging costs and/or an increased risk appetite, a fair assumption could be a reduction down to approx 45%. Tis would equate to approximately $37.5-$50 billion of sales of yen against USD/EUR/GBP/
Ricahrd Koo is famous for popularizing the idea of the “balance sheet recession” FX TRADER MAGAZINE April - June 2012 67
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