Yen: Battle Ground--Real Investors vs Speculators

Japan's Ministry of Finance publishes portfolio flows on a weekly basis. The latest data released earlier today shows the general continuation of recent trends. Japanese investors continue to buy foreign bonds and stocks. Over the past nine week, Japanese investors have purchased roughly $87 bln of foreign bonds and $15 bln of foreign equities.

Foreign investors have sold a little less than $20 bln of Japanese shares and sold a smidgen of Japanese bonds. The net portfolio flows out of Japan have been dominated by Japanese investors themselves.

On the other hand, non-commercials (speculators) in the IMM currency futures have gone been buying yen. Since early May they have swung from a substantial short position (65.6k contracts, ball park value $9 bln) to a long position (37.9k contracts, ball park value $5.2 bln).

Since early May, the yen has been easily the strongest major currency, rising almost 7.3% against the US dollar and more than 10% against the euro and nearly 12% against the Australian dollar.

The BOJ has not intervened in the foreign exchange market for several years. That alone would suggest that the bar is high. The strength of the yen is not desirable for country that anticipates to still be in the grip of deflation throughout the remainder of the year. However, BOJ intervention remains unlikely.

The market has been very orderly and intervention is not a tool that can be deployed simply because an official does not like the price action. Implied volatility has fallen from 16.5% in late May to about 11.25% yesterday. The premium the market pays for yen calls over yen puts, which may illustrate a skew in the market views and positions, is not extreme.

Implied volatility may increase if the dollar continues to approach the multi-year low set late last year near JPY84.80, but alone that may also prove insufficient to get spur official action. That said, given the changing political landscape in Japan, a combination of a strong yen and deflationary pressures could increase the pressure on the BOJ to take additional measures, such as increasing its JGB purchases, which currently stand at JPY1.8 trillion a month.