MUMBAI: The current dynamics in the Japanese financial landscape suggest a significant shift in capital flows, driven primarily by rising long-term yields and an attractive carry in Japan. As Japanese life insurers and other institutional investors reassess their hedge ratios and investment strategies, we anticipate a notable repatriation of capital back into Japan. This trend may lead to increased demand for domestic securities, potentially causing the global bond term premia to rise, as per experts.
For India, while it has been enjoying a premium over other emerging market equities, the potential for a broader market correction remains. Given the cyclical positioning of the Indian economy, it is prudent for investors to adopt a defensive stance in the near term.
"We note while the Japanese yield curve is one of the few globally, that still offers an attractive carry, Japan also remains the largest holder of USTs. Japan's Life insurers are one of the biggest holders of non-Japanese govt bonds and their estimated hedge ratio sits close to 50%. *A combination of higher long-term yields in Japan, an unattractive hedge ratio for Japanese corporates on overseas investments and a stronger yen, driven by other factors more than a hawkish BoJ will cause a repatriation of capital into Japan. This may cause the global bond term premia to rise," said Madhavi Arora, Lead Economist at Emkay Global Financial Services.
"India has been enjoying premium over emerging market (EM) asia equities, but it could still fall in tandem with the rest. On India's Cyclical Positioning, it is advisable to play Defensives in the near-term and reduce Midcaps positioning," Arora said.
"On positioning, we continue to hold our positive stance on staples like FMCG* (we cut our UW weight on the sector post elections poll) as we see early signs of cyclical rural demand recovery. We are also constructive on Healthcare. We would keep a watch on IT sector under the global macro backdrop," she further stated.
Concept of the "Yen carry trade."
This strategy involves investors borrowing money from a country with low interest rates and a weaker currency, then reinvesting those funds in another country that offers higher returns. The Yen carry trade has been particularly popular due to low volatility in the currency pair, with many market participants anticipating that Japanese interest rates would remain at historic lows. However, the Bank of Japan recently increased its interest rate to 0.25% from a range of 0.0-0.1%. This marks the second rate hike since March, when the central bank ended its ultra-loose monetary policy after 17 years.
The market is now expecting further rate increases in Japan. Additionally, the Japanese government intervened in the currency market with a substantial $36.8 billion to support the Yen, which had plummeted to a 38-year low of 162 against the US dollar. This intervention, along with the interest rate hike, contributed to a significant appreciation of the Yen, which strengthened from 162 to 142 against the dollar a roughly 12.5% increase in just a few days. Consequently, investors rushed to exit their carry trades to minimize losses. Notably, Japanese investors hold approximately Rs 2.05 trillion in Indian equities, and the stronger Yen has led to some selling activity among these investors.