Dollar poised to overtake 100 yen milestone on bold BOJ steps

Mon Apr 8, 2013 2:15am EDT

* Japan institutions will likely determine how far yen could fall

* Yen's fall could intensify if domestic investors sell-strategist

By Lisa Twaronite and Chikako Mogi

TOKYO, April 8 (Reuters) - A U.S. dollar bill could soon be worth the same as a Japanese 100-yen coin for the first time since April 2009, as investors price in the Bank of Japan's aggressive monetary expansion.

The yen plunged to fresh lows against major currencies early in Asia on Monday, coming within less than two yen of the 100 mark against the dollar, as the Japanese central bank took its first steps to whip deflation under its bold new scheme.

Once that milestone is breached, some strategists say profit-taking could temper the greenback's rally, though the appetite of Japanese life insurers for higher-yielding foreign assets is likely to maintain downward pressure on the yen for much of this year.

The BOJ conducted its debut bond-buying operation on Monday, purchasing 1.2 trillion yen ($12.35 billion) of longer-dated debt, as the first step of its stimulus plan unveiled on April 4 to inject about $1.4 trillion into the economy in less than two years.

The fact that the central bank wasted no time in backing up its vows with action vanquished any remaining scepticism about its resolve to beat almost two decades of deflation, giving yen bears more reason to smile.

"This has really shaken up many people's attitudes toward the BOJ and the new government," said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co in New York. "It feels like it's gathered a whole new momentum behind it, as the doubters have joined the bandwagon and it's becoming a self-fulfilling prophecy."

The dollar surged as high as 98.85 on Monday, gaining more than a full yen from Friday's late North American levels to its highest since June 2009.

Wilkinson, who in November last year predicted that the yen would test 100 per dollar as early as June, expects the 100-110 yen level will hold "for now."

But a clear sign of outbound investments from big Japanese institutional investors is crucial for the weak yen trend to take root.

Investment flows out of Japan and into higher-yielding, high-quality assets have already begun, with French, Dutch, Austrian and Belgian bond yields all falling to record lows on Friday in the wake of the BOJ's stimulus announcement.

FOCUS TURNS TO JAPANESE INSTITUTIONS

The pace of the yen's continued fall largely depends on the extent to which yield-hungry Japanese institutions follow suit, strategists say. With hedging costs low, their initial forays are likely to be fully hedged, though this could change as their risk tolerance rises in line with higher Japanese equities prices.

"With the BOJ's new policy squashing yields across the curve to super-long JGBs, the probability of Japanese life insurers' money flowing into foreign assets will rise significantly," said Yunosuke Ikeda, senior currency economist at Nomura Securities.

Japanese investors might consider removing hedges and start buying foreign bonds unhedged towards the end of the year, he said, when expectations grow that U.S. quantitative easing will slow and more investors believe the U.S. Federal Reserve is closer to exiting from its ultra-accommodative U.S. monetary stance.

After Japan's upper house election in July, rising expectations for the government to embark on structural reforms could buoy Japanese stocks, which in turn would boost investors' risk-taking appetite and could prompt more unhedged foreign bond buying, Ikeda said.

"Towards the year-end, the pace of yen selling may slow as short-term speculators unwind their yen short positions while long-term investors will continue to bet on a sustained weak yen trend," he said.

While the BOJ's push was clearly the catalyst for the yen's plunge, global economic conditions also contributed to the Japanese currency's downward spiral. As some economists cautiously believe the worst might be over for both the United States and Europe, the dollar above the 100-yen level would represent a return to the status quo.

The yen's record high of 75.311 against the dollar was struck in October 2011, against a backdrop of a debt crisis roiling European markets, and worrying signs about U.S. growth. Investors piled into the yen at the time for its safe-haven appeal relative to its global counterparts, but many of those factors have now faded.

Some strategists and investors fret that with the BOJ committed to its radical gamble to beat deflation, the yen's sell-off might become a one-way bet.

"If it takes a strong medicine to fix the malaise, my concern is what if the medicine's effect is felt too strongly," said Takao Hattori, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities.

"Japanese investors have yet to ride on the yen selling but if they start to do so, the move could accelerate," he said.

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