Forex Investment and Currency Trading

Contrary to anecdotal evidence, Japanese retail investors are still piling into overseas bonds.

The more interesting retail story, however, is the recent concentration of JPY leveraged shorts in NZD/JPY. Unwinding of these positions will compound AUD/NZD strength on the back of real money reallocation.

Retail investors still selling JPY
JPY’s resilience in recent months – JPY is the second best performing G10 currency after CHF year-to-date - is frequently attributed to Japanese retail investors reversing purchases on overseas assets as signs of domestic economic weakness have reduced risk tolerance. Recent flows data, however, provide no support for this hypothesis – retail investors have remained steady buyers of overseas assets and steady sellers of JPY, even during the three peaks of the contemporary financial crisis. JPY strength has its roots in JPY’s strong and growing status as a general proxy for risk and as a hedging instrument against moves in non-FX asset classes.

Although investment trust outflows are down from the 2006 peak, flows have remained consistently outward through the past nine months of financial turmoil.

Real money set to stay JPY-negative
Forward looking indicators also point to no let up in retail outflows from Japan in the near future. Reuters’ monthly survey of around 1000 Japanese retail investors on question “Which of the following
financial products are you interested in putting new funds into?” In the April survey, one in three investors cited overseas bonds or deposits, by far the highest since the survey began. Moreover, those expressing an interest in FX margin trades rose to 18%. This proportion has only been higher on one occasion – July 2007, just before the carry trade bubble burst.

While a steady stream of JPY-negative real money flows seems set to ensure JPY remains under general downward pressure on the main crosses during period of risk normalisation, Japanese investors’ renewed interest in leveraged carry trades throws up some more interesting cross currency inconsistencies.

Leveraged positions point to value in AUD/NZD
Overall short JPY positioning on the TFX is currently unremarkable, JPY218bn of net shorts compares to over JPY500bn at the peak of the carry trade and a long run average of JPY210bn. However, JPY shorts are more concentrated in NZD/JPY than has ever been the case before. As we argue in this week’s AUD&NZD Pulse, it likely that Japanese real money retail flows will shift in favour of AUD over NZD in the remainder of this year. The unbalanced nature of leveraged positioning in NZD/JPY
compared to AUD/JPY and the relative illiquidity of the former will magnify the negative impact of this on NZD, particularly against AUD, should retail investors liquidate leveraged long NZD bets.