LONDON (Reuters) - Concerns that Japan could exit stimulus sooner than expected have jolted world markets this week, including emerging economies where a stronger yen could persuade Japanese funds to dial back their slowly rising overseas allocations.
The yen’s surge after the Bank of Japan reduced its bond purchases on Monday lifted global bond yields and hit emerging currencies, many of which are suffering their worst week against the yen for months.
The BOJ has since restored the purchases, calming markets. But given that it already owns half the bond market, it may be close to winding down buying. When that happens, the yen could skyrocket as Japanese funds repatriate cash.
How big the emerging market fallout will be is hard to predict. But this week’s moves may offer a clue.
Emerging currencies fell between 0.3-0.8 percent versus the dollar. Against the yen, the Turkish lira has fallen almost 3 percent this week, while the Brazilian real, Mexican peso and South African rand have lost between 1.5-2.5 percent.
“The market has been interpreting what the BOJ did as that they may be reaching a peak in monetary accommodation and you have seen EM crosses react to that,” said Manik Narain, a strategist at UBS.
“Our analysis shows the EM share in Japanese portfolios has increased, though U.S. investors are still much larger players.”
The involvement in emerging markets of Japan’s intrepid brigade of mom-and-pop investors - known collectively as Mrs Watanabe - is well documented. But institutional investor interest has also grown, albeit slowly, ever since 2010 when the $1.2 trillion GPIF pension fund, one of the world’s biggest investors, announced it would allocate more to the sector.
Data from the Institute of International Finance estimates Japanese flows at around $66 billion since 2013, almost equally split between emerging bonds and equities.
Around $10 billion of that arrived during the first 10 months of 2017, the group says. But this is dwarfed by total portfolio flows of $235 billion last year to emerging assets.
Raphael Marechal, a portfolio manager at Japan’s Nikko Asset Management, said he had noted an uptick in Japanese money managers’ interest in emerging debt since he joined the fund two years ago, partly due to the sector’s strong recent performance.
In 2017, local emerging bonds returned 14 percent in dollar terms, though yen-based returns would have been eroded by the Japanese currency’s 3.5 percent gain against the greenback.
“It’s unlikely the yen is going to be weak and it’s likely that monetary policy in Japan will gradually tighten. But we are talking of (emerging debt) returns of between 7-10 percent so a 2-3 percent yen appreciation will not jeopardize the interests of Japanese investors,” Marechal said.
“The performance in yen terms will just be cut 2-3 percent.”
There is also, meanwhile, the mom-and-pop money, which has been rising after a slump in 2014.
Brown Brothers Harriman estimated that sales of uridashi bonds - issued in foreign currencies but sold to retail Japanese investors - reached $3.9 billion in emerging currencies in the first three quarters of last year, 51 percent of the total.
The most popular uridashi currency was the Turkish lira, accounting for 28 percent of sales, followed by the rupee, real, Mexican peso and the rouble, BBH said.
One thing that could indeed jeopardize the yen/emerging markets trade is - trade. This week’s yen surge was exacerbated by reports - later denied by Beijing - that China was mulling cutting U.S. Treasury buying as a form of retailiation for Washington’s increasingly protectionist stance.
“The revival of U.S. protectionism risk is negative for EM as a whole, more specifically Asia, and Mexico is already affected by NAFTA (trade pact) risks,” said Claire Dissaux, head of global economics and strategy at Millennium Global Investment.
Reporting by Sujata Rao; editing by John Stonestreet
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