Weekly update of key JPY flow developments: risk-on - Nomura

Analysts at Scotiabank explained that risk sentiment has stayed strong since the US presidential election, equity flows into and out of Japan have been strong recently. 

Key Quotes:

November MOF capital flow data showed a sharp slowdown in foreign bond investment by Japanese investors during the period, as volatility in the foreign bond market remained high.

In contrast, foreign equity purchases accelerated to JPY1279bn ($11.1bn), the biggest amount since September 2015. Weekly data showed small selling of foreign equities during the week ending 3 December, but there was likely short-term profit-taking. Foreign investors resumed purchasing Japanese equities recently too. 

Renewed foreign inflows into the Japanese equity market could be viewed as JPY positive, but as we argued before, FX hedge ratio adjustment flows by foreign investors could generate bigger FX impacts.

 If we assume 50% of new flows are FX hedged and foreign investors keep a 30% hedge ratio for existing exposure, FX flows related to foreign investment in Japanese equity could have reached more than JPY10trn in JPY buying in H1 2016. 

However, flows have been shifting to more JPY selling recently, as higher equity prices have forced foreign investors to buy USD/JPY to keep their FX hedge ratio constant. It is difficult to gauge their FX hedge ratio, but our ETF tracking on foreign flows into the Japanese equity market suggests a constant FX hedge ratio of around 50%. 

From 6 November to 3 December when foreign investors were consistent net buyers of Japanese equities, we actually estimated JPY4.3trn of JPY selling was generated from foreign exposure to Japanese equities. We have been pointing that globally the reflationary environment would be most negative for JPY in G10 FX space, and FX-hedging adjustment by foreign investors can amplify JPY weakness.

The BOJ’s decision to double its ETF purchases at its July meeting is also supporting the Japanese equity market, which is also working USD/JPY positive.