Yen Notes

The yen is largely sidelined as the market's focus is elsewhere--ECB policy trajectory, the European debt crisis, MENA, etc. This is reflected by the fact that dollar-yen volatility (implied 3-month) is sitting on its 3-year low near 9.55%.

At 45 bp, the US-Japan 2-year interest rate spread is a few bp above its 100-day moving average. At 218 bp, the 10-year spread is about 15 bp above its 100-day moving average. For all practical purposes the dollar is at its 100-day moving average (JPY82.60) and euro-yen is about 2.6% above its 10--day moving average. The move in euro-yen has largely been achieved over the past week and is related to the ECB rate signals.

Japan's January current account data reported earlier today was depressed by the calendar effect of Lunar New Year. The report confirmed what the merchandise trade report in late Feb already indicated that Japan experienced a trade deficit in January. However, data from Feb suggests the trade account swung back into surplus.

The time series is a good reminder of what we see as an important characteristic of Japan's external account. Like Switzerland, the driver of Japan's current account surplus has shifted over the years away from merchandise trade toward the investment income account. The investment income surplus was JPY1.01 trillion, this was the largest since last September and represents a 10% increase over year ago levels. The income still appears to be being depressed by the relatively low yields. As the global economy recovers and bond yields return to more normal (long term average) the investment income surplus is likely to grow.

There may be some passing interest in news that China bought JPY306 bln of Japanese bonds and notes in Jan and sold JPY171.3 bln of money market instruments. However, it is not clear how accurate this is as the UK's use as a financial center is obvious from the data. We note in this context that US TIC data has recently been revised to show much greater PRC holdings than the preliminary data suggested.

More important are the portfolio flows in general. In January, foreign investors bought a record JPY5.2 trillion money market instruments. This slowed in February, returning to more "normal" levels near JPY680 bln. However, foreign buying of Japanese bond and notes reached a 5-month high in Feb at a little over JPY700 bln. Foreign investors also bought almost JPY1 trillion of Japanese equities in Feb after JPY600 bln in Jan. That means that in the Jan-Feb period foreign investors bought more Japanese equities than they did in the prior 5-months combined.

On the other hand, the type of repatriation by Japanese institutional investors and insurers, often associated with approaching fiscal year-end does not seem to be taking place this year, as both market segments continued to buy foreign assets in Feb.

Lastly, as I noted yesterday, the net speculative position has swung back to a large net long yen position after running modest net shorts in the middle of February for a couple of weeks. At 41.2k (~$6.23 bln), the net speculative position in the largest since just before QEII was announced last November. There have been only four periods over the past decade that the net long yen position at the IMM exceeded 50k contracts. Data from Japanese margin trading (Tokyo Financial Exchange's Click 365) showed a record long dollar (short yen) position at the end of Feb of a little more than $3.1 bln